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ECONOMIC POLICY NETWORK

Policy Paper 2

TAX POLICY FOR EXPORT PROMOTION


(A study on Status, Constraints and Prospects in Tax Policy for Export Promotion)

Vidya Nath Nepal

August 2005

Prepared for: Economic Policy Network His Majesty's Government of Nepal/ Ministry of Finance Singha Durbar, Kathmandu, Nepal Tel: 977-1-4211353 E-mail: epn@mof.gov.np Website: www.mof.gov.np and Asian Development Bank Nepal Resident Mission Srikunj, Kamaldi, Ward No. 31 P.O. Box 5017, Kathmandu, Nepal Tel: 977-1-4227779 Fax: 977-1-4225063 E-mail: adbnrm@adb.org Website: www.adb.org/nrm

Submitted by: Federation of Nepalese Chambers of Commerce and Industry (FNCCI) P.O. Box 269, Kathmandu, Nepal Tel: 977-1-4262061 Fax: 977-1-4261022 Website: www.fncci.org

This report has been prepared by Mr. Vidya Nath Nepal, Macroeconomic Specialist, under the guidance of the Federation of Nepalese Chambers of Commerce and Industries (FNCCI). Inputs from various stakeholders during interactions at FNCCI, the Advisory Committee meeting, and the workshop organized by the EPN Focal Unit have been incorporated in the report. The names of people met during the interactions are included in appendix 11 in this report.

Foreword Economic Policy Network (EPN) is an undertaking of His Majesty's Government of Nepal (HMG/N) since August 2004 with the support of an Asian Development Bank (ADB) technical assistance (TA) to develop and institutionalize an open, responsive and result oriented economic policy formulation process based on sound economic analysis and dialogues with the partnership of public and private sector, academia, and independent professionals, to support and consolidate the Government's economic policy reforms on poverty reduction strategy. The initial focus has been in the areas of macroeconomic management, trade, investment, employment, infrastructure, tourism, agriculture, and regional development through four thematic advisory committees chaired by the secretaries of the respective implementing ministries, and guided by a high-level steering committee. The present study is an outcome of the initiative under the Advisory Committee for Macroeconomic Management chaired by the Secretary of the Ministry of Finance. Enhancement of Nepalese exports is not only vital for narrowing the trade gap, but also important for sustaining the balance of payments, and for creating employment in the country. The paper analyzes the economic, legal, administrative, institutional, and policy constraints for export and makes recommendations for tax policy reforms and procedural simplifications to promote exports from Nepal. The recommendations are the outcome of consensus reached among major stakeholders through various consultations and the EPN workshop. I hope the findings and recommendations will be helpful for policy makers for future reforms. I would like to thank the Federation of Nepalese Chambers of Commerce and Industries (FNCCI) for leading the study, and Mr. Vidya Nath Nepal for carrying out the study on their behalf. I also thank all those who have provided inputs for the report during the interactions at FNCCI, the advisory committee meetings, and the EPN workshop. The work of the Advisory Committee for Macroeconomic Management is to be commended for selecting the issue and for following through with the study. I would also like to appreciate the entire EPN team for their hard work. I also thank the former Steering Committee chairperson (the then Chief Secretary of HMG/N) Dr. Bimal Prasad Koirala, for his guidance during his tenure. Last but not least, I would like to thank the ADB for supporting this initiative.

Dr. Champak Prasad Pokharel Member National Planning Commission His Majesty's Government of Nepal [ChairmanEPN Steering Committee]

Acknowledgement This study is commissioned as requested by the Federation of Nepalese Chambers of Commerce and Industries (FNCCI) with the financial assistance of Asian Development Bank (ADB) under Establishing Economic Policy Network Project, Ministry of Finance. Rhetorically, export is said to be the engine of growth in economic development literature. It is also proven that countries which have outward looking policies have developed faster than those which have inward looking policies. However, this is a very competitive affair. Therefore, competitors have been providing different kinds of incentives, sometimes, including subsides which is not allowed by WTO. Nepal's position is very weak in this connection whereas trade deficit have been alarming. Nepal has been facing problems both physically and policy wise. Therefore, His Majesty's Government of Nepal (HMG/N) has realized to reform their tax policy among other things, for promoting exports as suggested by exporters, so that Nepalese exports can compete in international market. This study is the result of such realization. All stakeholders, FNCCI, MOF and ADB should be congratulated on this realization. First of all, I would like to thank them for entrusting me to undertake this important study. I would also like to thank the organizations, individuals and officials who have given their valuable suggestions and opinions in this regard. Dr. Champak Pokharel, Member, NPC and former Team Leader, Establishing Economic Network Project, MOF deserves special thanks for his positive and professional comments and monitoring of the study. Mr. Dipendra P. Dhakal, Team Leader, EPN deserves appreciation for his cooperation. I would like to thank Messrs B. P. Ojha, Secretary General, Dr. Hemant Dabadi, Executive Director, and Kedar Man Singh Shrestha, Senior Tax Expert of FNCCI for providing their support in different stages of the study. I would like to sincerely appreciate my colleagues Mr. Narayan Raj Tiwari, President, CPPD and Mr. Bansidhar Ghimire, Director, CPPD for their suggestions and encouragement to prepare the study. I would like to express my sincere thanks to Mr. Dilli Prakash Ghimire for his excellent professional cooperation without which the report might have not come out in time. Mr. Naresh Pokhrel, Under Secretary of MOICS deserves special thanks for providing latest information on export promotion measures in Nepal. I would like to appreciate Mr. Sabin Nepal for his hard work in the preparation of the report.

Vidya Nath Nepal Macro Economic Specialist

Abbreviation ACP ADB APZ BIMSTEC BOOT DDC DOC DOI DOIR DOLTM DOR EBA EPC EPZ EU FDI FIT FNCCI GDP GSP HMG/N ICD IEA LDC LDT MFA MFN MOA MOF MOFA MOHA MOICS MOLD MOLJ MOLT MOWR NCC NRB NTWC PPP RAC RMG SAARC SAFTA SEZ TIA TPC UNDP VAT VDC WTO African Caribbean Pacific Asian Development Bank Agriculture Processing Zone Bangladesh India Myanmar Sri Lanka Thailand Economic Cooperation Build Own Operate & Transfer District Development Committee Department of Customs Department of Industry Department of Inland Revenue Department of Labor and Transport Management Department of Roads Everything But Arms Export Promotion Council Export Processing Zones European Union Foreign Direct Investment Foreign Investment and Technology Federation of Nepalese Chamber of Commerce and Industries Gross Domestic Product Generalized System of Preferences His Majesty's Government of Nepal Inland Container Depot Industrial Enterprises Act Least Developed Countries Local Development Tax Multi-fiber Arrangement Most Favored Nation Ministry of Agriculture Ministry of Finance Ministry of Foreign Affairs Ministry of Home Affairs Ministry of Industry, Commerce and Supplies Ministry of Local Development Ministry of Law and Justice Ministry of Labor and Transport Management Ministry of Water Resources Nepal Chamber of Commerce Nepal Rastra Bank Nepal Transit and Warehouse Company Public Private Partnership Revenue Advisory Committee Ready Made Garments South Asian Association for Regional Cooperation South Asia Free Trade Arrangements Special Economic Zone Tribhuwan International Airport Trade Promotion Center United Nations Development Program Value Added Tax Village Development Committee World Trade Organization

Table of Contents Acknowledgement Abbreviation Executive Summary Chapter I Introduction ....................................................................................................... 1 A. B. C. D. A. B. C. D. E. Context of the Study................................................................................................ 1 Objectives of the Study ........................................................................................... 1 Methodology............................................................................................................ 1 Limitations ............................................................................................................... 1 Background of Export Promotion Measures and Tax Incentives ............................ 2 Present Status of Direction and Composition of Trade ........................................... 3 Potential Exportable Items from Nepal.................................................................... 4 Revenue Contribution of Export Sector................................................................... 4 Present Status of Tax Structure .............................................................................. 6

Chapter II Review and Present Status of Exports........................................................... 2

Chapter III Constraints and Prospects for Export Promotion Particularly through Tax Policy Reforms ...................................................... 9 A. B. C. D. E. F. G. H. Economic Constraints ............................................................................................. 9 Constraints in Policy.............................................................................................. 10 Administrative and Procedural Constraints ........................................................... 13 Constraints on Infrastructure and Logistics ........................................................... 14 Institutional Constraints ......................................................................................... 14 Legal Constraint .................................................................................................... 14 Miscellaneous Constraints .................................................................................... 15 Prospects of Tax Policy Reform ............................................................................ 15

Chapter IV Analysis of Primary Data and Comparison of Export Incentives in Neighboring Countries........................................................... 15 A. B. A. B. A. B. Analysis of The Responses from Stakeholders..................................................... 15 Summary of Incentives Given in Neighboring Countries....................................... 19 Public Private Partnership ..................................................................................... 20 Present Status and Perspective ............................................................................ 20 Recommendations ................................................................................................ 21 Conclusion............................................................................................................. 27

Chapter V Prospects of Public Private Partnership for Promoting Exports .............. 20

Chapter VI Recommendations for Improvements ........................................................ 21

Annexes Annex 1: Terms of Reference..................................................................................... 28

Annex 1 (A): Policy-Action Matrix ..................................................................................... 29 Annex - 2 (A): Exports of Some Major Commodities to Overseas Countries ..................... 36 Annex 2 (B): Exports of Selected Commodities to India................................................... 37 Annex 2 (C): Exports of Some Major Commodities to Tibet ............................................. 38 Annex 3: Annex 4: Annex 5: Annex 6: Annex 7: Annex 8: Annex 9: Annex 10: Annex 11: Bibliography List of Exportable and Potential Export Products of Nepal.......................... 39 Basis of Local Level Tax (Example) ............................................................ 40 Export Tariff Structure ................................................................................. 41 Prevailing Income Tax Rate and Slabs ....................................................... 43 List of Prohibited, Restricted and Freely Tradable Exports as Mentioned in Export Import Control Act, 1956............................................. 44 Response Sheet of Stakeholders ................................................................ 46 Comparative Table of Prevailing Incentives in Some Neighboring Countries. .................................................................................................... 50 Recommendation of Different Business Community and Rac on Export 2061 ................................................................................................. 52 Authorities and Stakeholders Met during the Study .................................... 55

EXECUTIVE SUMMARY 1. Nepalese exporters have been suggesting HMG/N for tax policy reforms and procedural simplifications since a long time. The government now has taken it seriously and initiated the study. The study is a part of Establishing Economic Policy Network Project, MOF with the assistance of ADB and channeled through FNCCI to reform in tax policy for export promotion by building consensus among stakeholders. The study has reviewed particularly the fiscal incentive packages implemented by the government and tried to identify economic, legal, administrative, institutional and policy constraints for exports. It has suggested particularly tax policy improvements with a policy-action matrix. This has also identified prospects for public private partnership in export sector. Export sector of Nepal has modest contribution in total revenue. However, it is obvious that its impact on employment generation, foreign currency earning and creation of backward linkages are significant. Share of the export tax to total revenue (customs duty and income tax) in 2002/2003 was 3.2 percent only. Likewise, contribution of income tax from exports to total income tax was 5.7 percent during the period. Similarly, revenue share of export from customs was 6 percent in this period. Constraints
Nepal's position is 119 out of 250 countries in attracting FDI and flow of FDI is

2.

decreasing. It is because of inconsistency in investment policies and lack of proper incentives. The present investment environment is a major hurdle to export oriented industries as well.
Lending policies of commercial banks are also not industry friendly. As a general rule exports are free from customs duties. However, at present,

export tax has been levied on 35 items ranging from 0.5 percent to 8 percent. Out of them about a dozen items are related to wood and stone which are related to natural environment protection. Some goods are related to vegetable ghee which is subject to import quota restriction in India. In the recent budget speech the VAT rate has been increased to 13 percent. Excise duty is limited to few products like alcohol and cigarettes.
At present, industries which are not in negative list i.e. which also includes export

oriented industries are allowed paying lower rate of only 75 percent of 20 percent reduced rate in income tax in spite of corporate income tax rate of 26.5 percent.
In addition to this, exporters in some cases are also supposed to pay local taxes

to VDCs, Municipalities and DDCs also in some cases levy area export tax on local products which adds extra burden to exporters.
At present, prevailing procedures of duty draw back system and bonded ware

house facilities including bank guarantee release provisions are cumbersome and time consuming whereas stipulated one window system in the act has never worked in Nepal.
There are many committees, councils, boards with duplication of activities in

export sector. There seems to be no coordination among them.


Plans and programs are in documents but due to ineffective institutional setup

they are not implemented properly in time.


Private sector has to be outward looking, more professional and with corporate

culture.

Laws and rules still are not industry friendly (such as Labor Act, Customs Act,

Industrial Enterprises Act, Income Tax Act, Export and Import Control Act and so on).
There is no separate bankruptcy act to deal with insolvency matters in time. Some non tariff barriers exist in the country where as there are a number of NTB

in our trading partner countries. 3. Recommendations: The study finds out that there are prospects to reform tax policy for export promotion particularly in income tax and tariff including the procedures which add costs to exporters. The draft report was presented in the seminar of stakeholders, advisory committee and a workshop comprising of academia, exporters and policy level government officials organized by EPN/ADB/MoF and suggestions received are included in the related paragraphs. The final summary recommendations are given below.
The impact of this situation will result into low investment from inside and FDI.

Neighboring states of India including Uttaranchal have special incentive packages for both internal investment and FDI. The consultant is reported that Uttaranchal has given better incentives to both internal investment and FDI than that of West Bengal, Bihar and UP which are our bordering states. Our policy makers will have to take this position into account in formulating policies for promoting FDI.
Many countries including our neighbors have given several concessions through

banking sector to make their exports competitive. Nepal needs to develop predictable, simple and concessional lending policy for exports. Initiative to establish a separate Exim Bank is recommended with the participations of private sector i.e. exporters and importers.
Exporters report that rate of tax is not a serious problem but there are a number

of hassles in our tax offices which have hindered smooth outflow of our exports and they are concerned with this situation. First and foremost they expect to make exports hassle free from the government side. Keeping this in view, most of exporters to overseas countries are ready to pay even 1.25 percent turnover tax on exports at the point of exportation at least for five years in lieu of prevailing income tax on export earnings or exempting 50 percent of income of export earning and levying in rest amount at present rate. These alternatives should be optional to the exporters. It is noteworthy that if 1.25 percent turnover tax on exports at customs is imposed in place of income tax on export earning, it has been found that this amount will be higher than the income tax raised by the government at 20 percent in the income on export earning. Majority of exporters including RMG, carpet, pashmina (Cashmere wool) and handicrafts sectors have strongly suggested replacing income tax on export earning by turn over tax to get rid of administrative hassles.
As a rule of thumb the study has recommended revenue neutral or zero tariff

rates on exports which is compatible with WTO rules. Keeping this in view customs duty structure may be revised. Tariff structure has important implications on exports. There is export duty ranging from 0.5 to 8 percent. At present export duty is attracted on some products which are of generally low value high bulk in nature and are generally exported to India and Tibet which has land border. The tariff rate should be redesigned after comprehensive exercise and cost benefit analysis in terms of exports and imports. If compulsions are there for the country to impose export tax on some goods for example to protect environmental degradation, they should be conceded. Export duty on vegetable ghee was imposed before 2002 while its quota was not fixed by India. As quota has been

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fixed now by India it is hard to justify 8 percent export duty on ghee products today. Similarly, all those items attracting export duty should be reexamined and the list should be minimized. The revenue loss from such steps can be recovered by strengthening customs control measures in border areas.
There is also possibility of avoiding local taxes levied by local bodies by designing

a new mechanism to refund if not exempted. Removal of the provision of local level tax on exports from Local Self-Governance Act and provisions of refund of such taxes if levied on the movement of goods from the factory or collection center up to the export point is suggested. As this tax is collected by local bodies, refund mechanism should be different than other government taxes. The tax levied on exports by local bodies can be refunded by creating a fund from local development tax levied on imports at entry by the government and transferred to MOLD by MOF.
Simplification of duty draw back procedures should be started by settling old duty

draw back cases as soon as possible. It is better to introduce the duty suspension scheme i.e. make pass book system simple and predictable and provide it to all export oriented industries. For example, we should develop a mechanism to include all producers through export houses to get refund or suspension of taxes not necessarily only big exporters but small producers in the system who by virtue of being below threshold are not registered in VAT and are not able to get refund at the moment. These small producers are working in handicraft, pashmina, carpet and garment sectors. Therefore, they should be benefited from the refund or suspension schemes. Duty draw back on flat rate system should be considered and rate may differ product to product.
Simplification of bank guarantee release procedures and automation of bank

guarantees release in each customs point including provision of online release of bank guarantees should be encouraged. Procedures of paying the guaranteed amount to customs should be simplified and predictable. The bank guarantee release procedures relating time and documents should be cut down as short as possible.
At present Nepal's export items are limited. In fact, Nepal has not yet developed

any product with the aim of exports so far. Main items of exports presently being exported from Nepal have been induced by external factor instead of our own internal product development efforts. In developing new products emphasis should be given to local raw material based products. However, software and hydropower products have high potential to Nepal. If we do not develop these items in near future we might loose the market because of competitions with neighboring countries and new technologies on the offing.
Both public and private sector have not yet made serious efforts to diversify the

market for exports. The government should negotiate effectively with bilateral countries, regional organizations and WTO capitalizing the least developed country status. Performance of our embassies and missions should be evaluated on the basis of their efforts and results achieved through economic diplomacy in respective countries.
In Nepal export house per se has not yet been materialized so far. During the

study period a royal ordinance has been issued in this connection. It is obvious that exporters and producers particularly smaller ones will be benefited with this provision and they can concentrate only on productions. But they will get benefit of exports i.e. rebate, concession and exemptions through the export houses.
Nepal is basically a country i.e. India locked, therefore, has to face transit

problem of different nature which are unique if one compares with other land

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locked countries. The second land route made available by Bangladesh again through India has not proved easy and simple so far. The government needs to effectively negotiate both with India and Bangladesh so that around 25 percent extra costs as transit cost for bulk items can be minimized.
There is plethora of institutions in promoting exports in Nepal, for example, TPC,

EPC and Trade Board etc. There is a need of avoiding such duplications of responsibilities and develop strong institutions to function effectively.
Nepalese policy makers have been formulating good policies in the past.

Unfortunately, they have hardly been backed by respective laws. Nepal has also been poor to update the laws, for example, in spite of liberal trade policy adopted by the government. The Export and Import Control Act 1956 has not yet been revised. Similarly one act contradicts with other act for example, Industrial Enterprises Act 1990 and Income Tax Act 2001. Labor Act has not been revised to make it industry friendly.
Nepal can consider increasing ceiling of sample of export items. We should

facilitate participations in international trade fairs. It is advised to provide subsidies at least to meet transport cost for fresh fruits, vegetables and cut flowers' export from the farms to Kathmandu and onward and develop facility of cold stores for the purpose of these agriculture items of export.
All neighboring countries of this region have promoted their exports in different

ways. Bangladesh has provided many export incentives to export oriented industries and exporters. Likewise, India and Pakistan have given many packages of export incentives. However, in comparison to Indian bordering states Nepal's export incentives are clearly lower which has higher cost of production for various reasons including extra transit cost. The study recommends minimizing the spread rate in lending export oriented industries. 4. Conclusion: Since long time Nepalese foreign trade is facing trade imbalances. There was huge trade gap in the year 2002/03 and thereafter. The alarming rate of trade deficit is demanding reform measures in foreign trade. The only way out to meet the trade deficit is to boost up our export. The remittance has become temporary remedy to meet the widening gap of balance of payment. There are many constraints mentioned above for export promotion. The international trade is developing in faster pace than before. The developing countries seem to be weaker partner in the global market. They should search better opportunities in the midst of challenges. All developed countries started reengineering their export policies in new situation. Nepal should address immediately all constraints including taxes and hassles, reform policies and create congenial environment for investment to be competitive in international market.

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CHAPTER I INTRODUCTION A. Context of the study

In order to give big push to increase investment in export sector and to attain economic grown through export of goods and services Nepalese exporters have been suggesting HMG/N to make suitable tax policy reforms for export promotion since long time. The government now seems to be serious to facilitate exports by designing timely and suitable tax policy. In order to help HMG/N, FNCCI with the assistance of ADB through Establishing Economic Policy Network Project under MOF has commissioned to undertake this study. This study intends to analyze present status, constraints, prospects and suggest recommendations in tax policy reform for export promotion. TOR of the study is given in annex 1. B. Objectives of the study

This study has the following objectives: To review the existing fiscal incentive packages implemented by the government, To identify economic, legal, administrative, institutional and policy constraints for promoting exports, To study the tax related problems the Nepalese exporters have to face that tend to lower competitive strength, To suggest particularly tax policy improvement or reforms with a policy-action matrix including simplification procedures, and To identify prospects for public-private partnership and suggest how PPP could be made more fruitful towards attaining of the desired export performance. C. Methodology

This study is based on following methodology: Literature review Consultation with stakeholders Analysis of primary and secondary data. Consultation with concerning government officials. Circulation of questionnaire to different business associations, individuals and persons involved in policy making in the government and analysis of responses. Group interactions with business community. Meetings with officials involved in policy making and implementation. D. Limitations

This study has following limitations: Study is based basically on secondary data and the secondary data were used until middle of 2004, Due to time constraint and the security reason field study could not be conducted, The issues on FDI in export sector are not covered in detail.

CHAPTER II REVIEW AND PRESENT STATUS OF EXPORTS A. Background of export promotion measures and tax incentives Trade sector has an important role to play in economic development. Realizing this fact HMG/N has been formulating various policies and programs directed to make the trade sector liberal and market oriented particularly after 1990s. However, low value of export over huge amount of imports has resulted to alarming rate of trade deficit continuously for long time. Trade deficit for the last 3 years is as given in Table 1. Table 1 Trade Gap Percentage Year 2001/02 2002/03 2003/04 Trade gap (in million) 42,235.5 53,390.5 60,882.5 Percentage change 0.0 26.4 14.0

(Source: NRB monthly economic indicators February April 2004) Since development measures were introduced in Nepal, emphasis was given to import substitution strategy. The reason was that until 1960's some products like rice, timber, leather, and residual items like bristle were used to be exported to India and also in other countries on premium price. Therefore, export incentives were not considered until new exportable products were developed. Before green revolution was successful in India even low quality rice were exported in good price. Attention was not given to developing new products and exporting them by introducing various tax and non tax incentives until 1960s. During the 1960's and 1970's the government started to adopt some important fiscal and monetary measures to promote exports. An example of such measures was Exporter's Entitlement scheme under which exporters of Nepalese goods in countries other than India were given a fixed percentage of their export receipt as counterpart import entitlement. That was called bonus voucher scheme and the voucher was saleable to other parties by original exporter. In 1977 the exporter's entitlement scheme was replaced by the Dual Exchange Rate under which all receipts from exports to the third countries were converted at second rate which was higher than general rate with the purpose to encourage exports to third countries. In 1990 cash incentive scheme also was introduced under which exporters of leather to countries other than India were eligible for the cash incentive. Beginning from the 1980s many important export items were exempted from export duties. Export duties on some items were reduced. Customs duty and sales tax (presently VAT) drawback scheme was instituted for imported raw materials used in the production of exported goods. Though the introduction of some export promotion measures were taken Nepal's general trade model was based on regulation and control. Import and export licensing, foreign exchange restriction, high tariff wall were the control measures adopted. Due to the conservative approach toward export trade, Nepal's export-import ratio could not be brought to balance and the trade deficit continued to grow in spite of some growth in the export sector. During the 8th plan period new trade policy was formulated with the objective of making the commerce sector more liberal, competitive and market oriented. The private sector participation was encouraged. Convertible foreign currency earned from the export of goods and services were made fully convertible in current account. Measures were taken to make duty drawback system more effective.

The current 10th plan in the context of growing trade deficit gives special emphasis on the diversification of the exports both commodity wise and country wise and promotion of exportable items of comparative advantages. The plan also emphasizes to undertake various promotional programs with the participation of the private sector and to the enhancement of the capacity of the institution that can play role in export promotion. The plan also aims to enhance the competitiveness of the exportable items by promoting foreign investment and technology in the areas of competitive advantage. The plan also mentions a program like the establishment of export promotion zones and special economic zones to support export oriented industry and harmonization of trade in line with SAARC and WTO membership. But there have not been sufficient reforms in the area of law, regulations and procedures and institutional improvement to bring in coordination of activities of different agencies of HMG/N to improve the existing trade regime and comply with WTO and other regional organizations. B. Present status of direction and composition of trade

Nepal's export trade until the beginning of 1980's was predominantly directed towards India. In the early 1980's nearly two third of the total export was directed to India. By the beginning of the 1990's, India's share in Nepal's export had declined to around 11 percent (1991/92). This directional change can be mainly attributed to the surge of the contribution of carpets destined to Europe and garments to the US respectively. However, exports markets to India started reviving from a meager 10 percent in 1992/93 to nearly 32 percent in 1997/98. The main reason for this increasing trend was Nepal's Trade Treaty with India in 1996 which was liberal than before in favor of Nepal. No quota was allocated for exports from Nepal to India and even 100 percent third country raw materials were allowed to be used in the production of Nepali goods to which were allowed to export into India. There were only three items in negative list for preferential entry into India i.e. cigarettes and tobacco, beverages and alcohol except for industrials purposes and non Nepali and non Indian brand cosmetic goods. However, these goods could be exported on MFN basis. Moreover rules of origin were made very simple without any value added condition. It so happened that this treaty is credited to have triggered major FDI's by some large companies like Dabur, Hindustan Lever and Colgate Palomolive. These companies also have been exporting their goods to India. In the year 2001-02 India's share in Nepal's export reached 59 percent. In the year 2002/03 and 2003/04 the percentage of Nepal's export to India stood at 52 and 57 percent respectively. Except India, USA and Germany remained two leading countries for Nepal's export trade. However, Germany's relative contribution has been on the decline while that of US has also been declining due to expiry of MFA at the end of 2004. Germany and the US took the lead over India which ranked third to Nepal's export market up to the year 1996/97. From 1997/98 India has taken the lead once again. Export products like vegetable ghee, copper scrap, zinc oxide, and acrylic yarn increased. Later on Indian authorities protested the surge in imports from Nepal and in order to address India's concern export duty are still being levied by Nepal on such items. Regarding third country trade quality problems and concern in importing countries over child labor adversely affected major export item i.e. carpet. The fall in the garments export is probably due to inability of the Nepalese industry to compete with exporters from others South Asian Countries. It is understood that Nepal is facing competition with ACP countries which are exporting garments to US market on preferential arrangements. These facilities to Nepal are under consideration in US senate at present. If we take out carpets and garments from the total export, India is the single largest and stable market for Nepal's export. Major primary items of exports to India are Catechu, Oilcakes, cardamom, animal feed etc and manufactured items exported are noodles, wheat flour, tooth paste, soaps, MS pipe, plastic items, corrugated sheets, zinc sheet, GI pipe, textile, juice, hair oil, wires and some readymade garments. Though India has taken the lead on Nepal's export, the export volume

declined due to the quantitative restrictions in the 2002 Trade Treaty with India. Items that are put under such quantitative restrictions in the Treaty are vegetable ghee, copper related products, zinc oxide and acrylic yarn. In fact the trend in FDI which is essential for expanding export trade is set to have slowed down after that but this could be for other reasons like the on going insurgency situation. Export of readymade garment is the topmost export item to the overseas countries followed by the woolen carpets. The third item among the major export items is pashmina. Combined contribution of these items in the exports of the third countries was 79 percent in the year 2002/2003. Other important export items to the third countries are metal and wooden handicrafts, processed leather, lentils, tea and herbs etc. These handicraft products have high degree of domestic labor and raw material contents. The export of major commodities to different countries with value and quality is given in annex 2. Components of present export oriented policy are: License is not required for the exports of product except for items that are banned or quantitatively restricted. Duty draw back scheme is being implemented. Bonded ware house facility has been started to be given to industries in addition to garment. In general no duties are levied on most export except the negligible service charge. Export valuation system is abolished. However, reference price of carpets is still fixed by the government. Simplification and reduction of export procedure and documentation. Exchange rate policy which impacts on exports Full convertibility of Nepalese rupees in current account Facility to open convertible currency account as specified by NRB and to retain deposit accounts in convertible currency Facility for the procurement of industrial raw materials and machinery from India in hard currency which helps to reduce the cost of production for exports. C. Potential exportable items from Nepal Concentration of export trade in a few items and destinations is vulnerable and dependence on import of raw materials to manufacture exportable products like garment, carpet and pashmina shawl is the causes of low value addition. The list of potential export items are mentioned in the annex 3. D. Revenue contribution of export sector

Export sector of Nepal has modest contribution in total revenue. The following table reveals that the export performance declined in 2001/2002 and slightly increased in the year 2002/2003 which still is below the level on 2000/2001. It is obvious that its impact on employment generation, foreign currency earning and creation of backward linkage are significant. The share and revenue contribution of export to total revenue are shown in the following table:

Table 2 Revenue Contribution of Export Rs. In million Descriptions 2000/001 2001/2002 2002/2003 Export volume 55654.1 46944.8 49930.6 India 26030.2 27956.2 26430 Other Countries 29623.9 18988.6 23500.6 Import 115687.2 107389 124352.1 India 45211 56623.1 70924.2 Others 70476.2 50766.9 53427.9 Total volume of trade 171341.3 154333.8 174282.7 Total customs Revenue 12552.1 12658.8 14236.4 Contribution of export 492.6 917.4 855.6 Revenue share of export from 3.92% 7.24% 6.0% customs Total tax revenue 38865.1 39330.6 42587.0 Revenue from export 1049.1 1386.8 1354.6 o revenue from customs 492.6 917.4 855.6 556.5 469.4 499.0 o revenue from income tax Share of export taxes on total revenue 2.7% 3.5% 3.2% Total revenue from income tax 9546.5 9465.7 8691.5 Share of income tax from export 5.8% 4.9% 5.7% earning on total income tax revenue (Source: Economic Survey 2004 except Income tax on exports at 5 percent profit turnover is estimated by the consultant). LDT is not included. The figures presented in the above table reveal that the share of the export tax to total revenue (customs duty and income tax) was only 2.7 percent in 2000/2001 and 3.2 percent in the year 2002/2003. The share is not significant. Likewise the share of the income tax from exports to total income tax revenue is 5.7 percent. The contribution of export tax and income tax and combined to total revenue are given in the following bar charts:Chart 1

18,000 Rs. in Million 15,000 12552 12,000 9,000 6,000 3,000 0 2000/01 2001/02 2002/03
Contribution of export Total customs revenue

12659

917

14236

493

Chart 2

856

50000 40000
Rs. in Million

30000 20000 10000 0

38865

39331

42587 1387
Chart 3
469.4 8691.5 2002/03

2000/01 2001/02 2002/03


Total tax revenue Contribution of export tax (income + customs)

20000

Rs. in Million

15000 10000 5000 0 2000/01 2001/02

9546.5

1049

556.5

9465.7

(Contribution of income tax on export earning on total income tax revenue) The above chart 1 reveals that the contribution of customs from export to total customs revenue was 6 percent in the year 2002/03 while it was 3.9 percent in the year 2000/01. The chart 2 shows that the share of export taxes to total tax revenue. The share of export taxes (income + customs) on total tax revenue was 3.2 percent in the year 2002/03 while it was 2.7 percent in the year 2000/01. Thus the contribution of export tax is not significant in the composition of total revenue. The chart 3 exhibits the share of income tax from export on total revenue from income tax. The share of income tax from export was 5.7 percent in the year 2002/03 while it was 5.8 percent in the year 2000/01. E. Present status of tax structure

Income tax: The Industrial Enterprises Act 1992 exempts income tax on the income earned from exports. This provision is also stated in the Trade Policy and the plan documents of HMG. In spite of this policy the exporters are subjected to pay income tax on income earned from the export. Income Tax Act 1974 had provisions to honor the arrangements of Industrial Enterprises Act. The old Income Tax Act was replaced by Income Tax Act 2001. The new Income Tax Act brought export earning into tax net. This is evident that there is lack of coordination between the MOF and MOICS. Income tax is not levied to the individual up to Rs. 100,000 and for the couple up to 125,000. Thereafter the rate is 15 percent up to Rs

499

1355

125,000. Exceeding Rs. 125,000 to Rs. 175,000 the flat rate is Rs. 11250 and above Rs. 175,000 the rate is 25 percent. For the corporate sector there is no such exemption on slab. But the rates of industries which are not in negative list i.e. including export oriented industries is reduced to 20 percent and for export oriented industries only 75% of the rate (20%) is levied. Tax payers pay self assessed tax on their income. Tax audit is made by officials after several years. Most of the tax payer's organizations, tax payers and others complain that income tax is assessed arbitrarily by tax administration. Income tax, other taxes and duties are re-assessed and demanded accounts and errors with the tax payers after a long time. This situation is a situation of complete uncertainty. Reassessments are made for several reasons including audit objection. In their opinion this practice is too much risky for businessmen because they cannot wait for along time to give bonus to employee and dividend to the share holders and clear other liabilities based on profit. Customs duties: As a general rule, exports are free from customs duties. However, exports tax has been levied on a number of items ranging from 0.5 to 8 percent. Majority of items attract only 0.5 to 1 percent customs duties. Duties in some cases are ad valoram while they are specific for others. Besides, carpet exporters pay service charge of Rs. 2 per square meter for obtaining GSP certificate. Export is supposed to be free from customs duties in general but the government has been imposing and changing duty rates on few items from time to time. This resulted inconsistencies in policy. Exporters complain that inconsistent duty policies will affect the long term export planning resulting to un-competitiveness of export products. Some export items are taxed for the purpose of conservation, to save environmental degradation and perhaps to honor the commitment of trade treaty with India. Local taxes: VDCs, Municipalities and DDCs are allowed to levy area export tax on local product and on kabadi. The district export tax works as exactly as export tax in case the product is exported outside the country through their area. In the case of raw materials used to manufacture exportable products by bringing raw materials from one district to another, the LDT works as duty on raw materials. LDT rate is specific. The basis of local tax is given in annex 4. Other taxes: In addition to customs duties, the exporters have to pay service charges of Rs. 500 per declaration form. The system of fixing minimum floor price of carpet has been replaced by a system where in reference price is fixed for the purpose of customs valuation. Carpet up to 80 knots the reference price is fixed at US$ 32 while the carpet beyond 80 knots the reference price is fixed at US$ 75. Sales tax was replaced by single rated value added tax in the year 1997. The rate of VAT was 10 percent. Both domestically produced goods and imported goods are taxed at the same rate. By the Financial Ordinance 2061 the VAT rate has been increased to 13 percent. So far the excise duty is concerned it is limited to few products. If the products are exported they are also subject to duty draw back scheme if taxed at all. Duty drawback scheme: The rational behind the import duty exemption on raw materials is that the final goods and services are consumed in foreign countries. Goods and services which are consumed in foreign countries need to be make duty free to make exported goods competitive. Duties on goods and services are levied to protect domestic industries, to reduce consumption and to generate revenue. Among these three purposes only revenue raising objective is applicable to impose duty on raw materials. Therefore, the duties paid on imported raw materials are refunded. Many countries provide duty exemptions on export and duty draw back on raw materials to make exportable products competitive in international markets. Duty exemption scheme may include either duty drawback facilities or having no duty on imported raw materials to manufacture finished products for export. The Industrial Enterprise Act 1992 has given facilities of duty reimbursement for exported items. According to the Act the customs duty, VAT, excise duty levied on the raw materials and auxiliary raw

materials and intermediate goods utilized by any industry in connection with its products shall be refunded on the basis of the quantity of export. The Act has given exemption of tax, duty or fee on the imported raw materials to be employed by an export oriented industry. The Industry selling its products to the Export Promotion House and goods produced in EPZ are also entitled to get reimbursement of the customs duties and VAT levied on the raw materials imported for producing the products so sold. Such export promotion zones and houses have not been operational till writing this paper. But a royal ordinance has been issued in this connection recently. From the perspective of export incentives, the Act is sound but in the implementation there are complains. The duty drawback scheme has performed poorly, the procedures to obtain duty drawback is cumbersome and requires various types of documentation. The process involves various departments and ministries and there is lack of coordination. The exporters complain about delay in getting the refund, whereas some have not received the refund for a long time. At present the refund is not made in cash but in the form of government bond. Exporters feel that duty suspension scheme is better over duty draw back facility which avoids tying up exporter's working capital. The problem with duty suspension is that all goods produced by imported raw materials may not be exported. The spillover of raw materials and finished products in domestic market is high particularly in those products which are consumed in domestic market and exported too. Therefore, for revenue protection duty draw back system was preferred and incorporated in the Industrial Enterprises Act. One window system was also established under the DOI to provide facilities including duty draw back. However, the one window system has not been functioning properly. Bonded warehouse facility: The Bonded Warehouse system was introduced in 1988 with a view to promote the export of readymade garments by reducing costs and the administrative burden related to imports of raw materials. Under this system exporters import raw materials, keep it in a warehouse under bond, by submitting bank guarantee for duties payable to the customs and get the bank guarantee released after completion of the export. In the beginning the bonded warehouse facility was allowed to garment producers exporting garments to the third countries. At present the bonded warehouse facilities have been extended to the following categories of exports. Industries exporting garments to India and the third countries. Industries exporting their products to the third countries. Industries exporting minimum eighty percent of their production to India except (a) above. Industries entitled to get bonded warehouse facilities required to provide the customs with six months bank guarantee for the amount equivalent to the customs duties chargeable for import of raw materials and auxiliary raw materials used in the exporting products. In order to get the bank guarantee released the exporter is required to submit the documents proving that the export has taken place. The evidence of the foreign exchange earning as well as proportion of the raw materials used in the final product has to be submitted to the customs. An exporter unable to submit the required documents to release the bank guarantee in the stipulated time is subject to pay the customs duties on the raw materials imported at the rate applicable on the day of importation. Plus additional 50 percent customs duty is also levied for delaying to release the bank guarantee. Likewise the raw materials / auxiliary raw materials imported but not used in the final export product is also subject to levying applicable customs duty plus additional 50 percent customs duty applicable for the product on the day of importation.

Export processing zones: The Government has proposed to establish EPZ which is important component in the government's export promotion strategy. The proposed sites for the EPZs are at Bhairawa, Nuwakot, Paachkhal and Birgunj. At Bhairawa, land has already been acquired and the other infrastructure development is undergoing. The feasibility study is being conducted in respect of other EPZ's of Birgunj, Panchkhal, Nuwakot. It is understood that the act is being drafted towards this direction in the government.

CHAPTER III CONSTRAINTS AND PROSPECTS FOR EXPORT PROMOTION PARTICULARLY THROUGH TAX POLICY REFORMS A. Economic constraints Nepal's financial sector is too small to meet the increasing demand for investment in general. Similarly, economy has several other constraints like lack of proper technology, high transit cost, low level of productivity, low quality and other infrastructural problems etc. Commercial banks and development banks have been asked to appropriate a certain portion of their investment to the export sector in the past. The practice has been stopped. There are increasing complains from entrepreneurs engaged in export business concerning the lack of adequate finance at reasonable interest rates. FDI has been recognized as an important source of capital for the purpose of export growth as huge investment is needed to develop the export oriented industries. Even after the production takes place capital is required in other successive stages of export performance. Despite substantial liberalization of the trade and industrial regime, Nepal has been relatively unsuccessful in attracting the FDI in comparison to other least developed countries. Moreover the available FDI has not been sufficiently directed towards the export sector. The Labor Act of Nepal has made difficult provision to dismiss the workers having permanent status. Similarly it is also difficult to close the business firm for which the firm requires permission from the DOLTM. Thus, there is a need of developing a system to freely hire and fire in the interest of the firm so that laborers are committed to their jobs and increase productivity. In doing so, minimum wage rate of laborers should be fixed reasonably to fit in there productivity and the national norms. The recent construction of ICD in Birgunj, based on rail and in Bhairawa and Biratnagar, based on road was supposed to address the transit costs involved. However, there is lack of simplified procedure of customs processing for moving containers to and from the ICD. It seems that the handling cost of ICD is more than handling cost of NTWC. Ironically neither ICD facility is properly utilized so far nor Fulbari-Banglaband alternative land route for transit has been used fully. Road facilities are poor in Nepal; movement of transport is often obstructed during the monsoon. Further, being a landlocked Nepal has to depend on the infrastructure provided by transit giving countries which is not in our control. Except for telecommunication, Nepal is poor in other infrastructures. Electricity cost is incredibly high in Nepal. Acquiring new technology is important to make export qualitative and competitive. Technology transfer mechanisms are weak among the Nepalese exporting firms. Insufficient access to the latest technology in the export promotion activities, costs involved in access to licensing agreements and lack of in-house training program are the broad reasons for weaker technology. Quality control for exports covers many steps like standardization, certification, testing, inspection which demand such organization as certification bodies and testing laboratories to

be properly equipped. In Nepal Bureau of Standardization and Quality Control and Department of Food Technology and Research are the concerned organizations for these purposes which are located basically in the capital. Further improvements are needed to enhance their technical capacities and such facilities should also be made available in the major export points as well.

B.

Constraints in policy

Trade liberalization is the commonly used term particularly after the formation of WTO and other regional trade blocks like SAFTA. Despite advocacy of free trade many countries have been creating barriers in international trade by the instruments of trade policy. Such barriers may be based on tariff, price, quantity and quality etc. If the policy of reducing cost of production is not adopted the product in the international market can not compete. If the cost of imported raw materials becomes high naturally the cost of the final product goes up making the export uncompetitive in international market. Indian budget of 2005 has made provisions of textile development fund to facilitate export of textile after expiry of the MFA. This fund is likely to help Indian textile products to increase competitiveness. Nepal has no such quick response to develop garment industries so far. The latest Trade Treaty between India and Nepal limits the scope of export trade flow of Nepal to India. There is import quota system in India to certain Nepali commodities. The Trade Treaty of 2002 with India has actually limited the export of vegetable ghee, copper wire and zinc oxide and acrylic yarn where as Trade Treaty of 1996 had provided duty free access of manufacturing goods produced by using imported raw materials even 100 percent to India without quotas. The duty free access was for all goods except the goods mentioned in the negative list. The restrictive provision of rule of origin and allocation of quota and other non tariff barriers in the treaty of 2002 has cut down the availability of large Indian market to Nepalese products. Nepal has no direct access to the sea. Nearest sea port is located in India which is at the distance of 660 miles from mid Nepal. These factors make transport cost high and limits the competitiveness of Nepalese commodities in the international markets. If preferential entry is not given within stipulated time by the USA, the competitiveness of garment industries will be further eroded. Nepalese exporters have to pay extra cost at the land border and at the final shipment. Thus Nepalese export items become expensive to the end users and loose competitiveness in the global market. Existing arrangement allows the Nepalese traders to use Mongla port of Bangladesh through Phulbari-Banglabandh i.e. India-Bangladesh land border. The port has been used in a limited way by Nepalese traders so far. Main reasons for limited use of Mongla Port are businessmens familiarity to Kolkata and insufficient infrastructure from Bangladesh border to Mongla Port. In addition to this businessmen report that cost for escorts of convoys of exports in Indian territory is cost prohibitive among other things. The Industrial Enterprises Act, 1992 has made provisions of income tax exemption on export income where as Income Tax Act, 2001 made provisions to levy income tax on export earnings too. Trade policies are developed by various agencies with multiple objectives. It is obvious that there is no coordination between other agencies and revenue departments. Apparently such policy inconsistencies become barrier to long term production plan of exportable items. 1. Constraints in investment policy: Flow of FDI is very low in Nepal. Recent study shows that Nepal's position is 119 out off 250 countries in attracting FDI. It is much lower than

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Cambodia. In areas of investment there are many authorities in Nepal responsible for providing concessions, facilitation and approval. The private sector is always concerned about the unpredictability of investment policy of the government. Present rules related to FDI seem to be liberal in principle, but in practice, they are vague and less friendly to investment. It is clear that without good investment climate the production cannot be increased and export cannot be geared up even with liberal fiscal incentives.

2. Constraints in lending policy of financial institutions: It is the general inclination of financial institutions to lend in trading sectors. They are not so enthusiastic to lend in product development areas. The banks while financing import trade do not keep sufficient mortgage. This leads them towards huge amount of bad debt in trading sectors. Their reluctance to invest in exportable product development activities i.e. industries is also great constraint. The banking sector does not seem treating industry as its partner. Financial sector should treat them as complimentary to their functions. Due to the lack of mutual confidence and proper monitoring in time many industries are blacklisted for being defaulter. Such activities always become hassles in development of exportable commodities. Efficient banking sector always should become investment and export friendly of course in selection of industry with proper screening and monitoring. 3. Constraints in customs policy: It is a well known fact that one of the commonly used export promotion policy instrument is exemption of tariff or customs duty. The purpose of the policy instrument sometimes may be revenue to the treasury or export promotions or protections to the domestic industries. This becomes a means of incentive to export making the product cheaper and competitive in international market which is not sufficient. On exports, HMG has tried to provide different type of incentives in the past. Export duty has been basically non existent in Nepal with some exceptions. Present tariff structure is shown on annex 5. Customs duty has been exempted in the import of industrial raw material and auxiliary raw materials of export oriented industries also. The duty structure for exports runs from the range of 0.5 to 10 percent only with some exception for export banned items which attract even 200 and 70 percent tariff rate. Today most of the nations are adopting zero tariff rates to enhance their export in international market which is allowed by WTO rules. Thus in the context of export competitiveness, Nepal also has to revisit her export tax policy. The principle of revenue neutrality has been accepted in Nepal in the context of attracting tax on exports. At present, there are few commodities on which export duty is levied. Our tariff structure also has followed the tariff pattern of other developing countries. Nepal has knowingly adopted cascading tariff rates which give higher protection to the producers of consumer goods and lower protection to intermediate goods. Therefore, the marginal rate of export duty should be restructured. Import duty rebate to the export oriented industries can be good incentive to export trade. The present export tariff structure is not so high to make export trade to be non-competitive in the international markets. However, these rates may be reviewed. 4. Constraint in tax policies: Income tax generated from export earning is not significant in Nepal as described above. The share of export tax is only 3.2 percent in total tax revenue in the year 2002/2003. In principle, there should be no discrimination in levying income tax on equal income earned from any source. Therefore, to provide rebate on income tax earned from export is contradictory in principle. There should be equal treatment to all profit, and it is also the right of tax payer to get equal treatment through tax rate. If income tax is levied at different rates, the income may be shifted from higher rate to lower taxed business or from taxable sector to non taxable sector. Another major hurdle is the problem of separation of net income of export from the total income of the concerned entity. The prevailing income tax slab and rate are given in annex 6. However, income tax naturally increases the cost of exports.

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VAT is refunded on exports after verifying the export documents such as declaration form, letter of credit, bills of entry, and proofs of payment of duty and taxes and purchase invoices to authenticate tax paid on all inputs. Revenue administration advocates that the process of Vat refund is simple. The exporters argue that the process is very lengthy. Thus there is continuous dispute on VAT refund to exporters. It is one of the hassles in export facilitations. Tax payers complain that they should reach into some sort of compromise even to get their refund applications registered in the record of tax office. There is the legal provision of providing VAT refund within 60 days after the registration of their refund application. To avoid the date line the officials do not register refund application on receipt. To address this issue the Inland Revenue Department has introduced new system in which the tax payers do not need to submit separate VAT refund application but need to fill up the single column in the tax return form. This also has not facilitated VAT refund due to lack of prompt processing. Recently made provision of VAT refund at the airport to tourists has also not been implemented so far which could also promote exports. At the point of import taxpayers pay VAT on imported raw materials. After production if they export goods outside Nepal VAT paid on raw materials is proportionally refunded. If it is soled domestically, they charge to the domestic buyers of the goods. The export oriented industries demand that if their products are wholly exported they should not be bound to pay VAT at the customs. For revenue security bank guarantee should be allowed for VAT liability too. HMG/N has accepted the demand by incorporating the provision in finance ordinance of 2061. But the procedures of the provisions are not clear and simple. Traders complain that bank guarantee release procedure is very cumbersome. There is no well defined mechanism of VAT exemption and refund to the end users and small producers who are below threshold. In order to reduce the cost of production of items like handicrafts, handlooms and small units a mechanism of VAT refund by HMG/N or transfer the VAT refund benefits through exporters is essential. The neighboring country India is also going to levy VAT at the rate of 0, 1, 4 and 12.5 percent from April 2005. Under the circumstances, Nepalese importers of raw materials will have to deposit more or supply bank guarantee for higher amount in comparison to Indian importer of the same raw material. This will raise the cost of production of Nepalese industries making Nepalese exports less competitive in international market. 5. Constraints on local tax policy: There is problem of local taxes levied by local level bodies such as VDCs, municipalities and DDCs. These local taxes are also impediments to Nepalese exporters. Local Self-Governance Rules allow to tax on movement of products only from originating districts where as producers and exporters have to pay local taxes in different districts and municipalities on the way. Local institutions are allowed to levy local taxes under Local Self-Governance Act on export as well. Consignments moving from villages' districts and municipalities are bound to pay local taxes. There is no provision of refund of such local taxes either in Industrial Enterprise Act or Local Self-Governance Act. These activities make Nepalese export less competitive in international market. 6. Constraints in diversification of products and market expansion: So far our export basket has been extremely limited. Exportable products to India were basically high bulk low value agriculture and residual items of primary nature until 1990. However, recently some manufacturing items have appeared in the basket. There are also very limited items exported to third countries i.e. RMGs, pashminas, carpets and some handicrafts. Similarly, exports to Tibet are basically food items.

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Nepal's performance in diversifying market has not been encouraging. Both government and private sector have not shown progress for quite a long time to diversify market. Market of RMG, pashmina and carpet including some agriculture items could be diversified in many destinations than the present limited countries. In this connection our missions abroad have not helped seriously for marketing of our products in their respective countries in collaboration with the private sector. Similarly both private and public sector hardly have tried to get better access through the provisions of multilateral and regional organizations like WTO, SAFTA, BIMSTEC and EU, EBA preferential arrangements. It is also true that we have high cost of production and quality of products has not been competitive in international market. C. Administrative and procedural constraints

Although this constraint is not new one, the story of export promotion would remain incomplete without addressing this issue. The exporters are complaining about red tape and administrative delays resulting to high transaction costs. There is no accountability and transparency in the functioning of the government and there are frequent changes of the government and senior officials. Our policies are liberal but there are hurdles in implementations i.e. lack of coordination among government agencies. Different interpretation of rules and regulations results ad-hoc decisions. Policy document commit to provide one window service to foreign investors. But either committee does not meet or its decisions are not implemented by concerned government agencies. Tax payers complain more about the hassles than tax rate. 1. Procedures of bank guarantee release: The import duty on industrial raw materials can be released by recording import of raw materials in pass book or submitting bank guarantee related to export. Under the pass book system revolving deposits needed. The bank guarantee for six months is needed to import under bonded warehouse facilities. The involvement of capital under pass book system and long process of bank guarantee release under bonded warehouse system add additional costs to exporters. Business communities are demanding to simplify the process of bank guarantee release in various forums. There is complain of custom officials that the guaranteed amount of duties are not paid in time by concerning banks. 2. Duty drawback scheme: The export oriented industries can import raw materials under bonded facilities and can export the products. This is one of the duty exemption scheme commonly used in developing countries. In cases where import duty is paid on imported raw materials duty is refunded in proportion to the raw materials used in exported goods. This system of duty draw back is working very poorly. The scheme has become costly by blocking the working capital of the exporters (or entrepreneurs) for a long time. The business communities complain that the process of duty refund is not clear and simple. In most of the cases the exporters have to wait for a number of years to get the duty refund. Thus the export promotion scheme has not been effectively implemented as stipulated in Industrial Enterprises Act. Due to internal causes working capital of exporters has been blocked and needs to be addressed by the government. The manufacturing industries either replace import for domestic consumptions or provide articles for export. The industries are getting duty rebate on industrial machineries and plants of Chapter 84 of Customs Classification Code in which the tariff rate is 5 percent. They do not get duty rebate on parts of the plant and machineries. 3. Provisions of deemed export: If construction materials sold to foreign aided projects they are deemed to be export under Industrial Enterprises Act. The deemed export used to get duty draw back. Finance Ordinance do not have the provision of deemed export. If intermediary industry sells it's product to the export oriented industries the former industry

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also should get the facilities of deemed export. In the Finance Ordinance 2061 there is a provision for cotton producers to get such facility. In the absence of defined procedures the provision has not yet been implemented so far.

D.

Constraints on infrastructure and logistics

Communication plays the great role in international trade. The development of modern communication system is satisfactory in Nepal. If the cost of communication is high, it imposes extra cost to exporters. The internal transportation cost also is very high in Nepal. The road conditions are not good. So, the cost of transportations and roads conditions are also additional cost element to the export trade. Infrastructures of customs are very poor which are time consuming and ultimately cause increase in export cost. The air freight or transportation cost is very high which makes our export expensive in international market. Transit cost has been dealt with earlier. E. Institutional constraints

There are no efficient organizations and institutions for promoting exports. Of course there is plethora of committees', councils and boards with the same objective for promoting exports and all of them are not functioning properly. There is no special cell in the ministry or TPC which can liaison with our missions abroad to feed them about our export policies, programs and products and to collect information about the demand of items and their customs duties in respective countries from the missions. Neither private sector has such arrangement so far. Present TPC is not functioning effectively for various reasons. There is no special financial institution such as exim bank to finance export and import activities in Nepal so far. Our export policy, plan and programs seem to be in documents which are never monitored or implemented. Export business is the affair of private sector where government can only facilitate. Nepal's private sector needs to develop professionalism and corporate culture. F. Legal constraint

Besides all policy and procedural constraints as mentioned above there are certain legal constraints too. At present, audit for valuation purpose is conducted in ad-hoc basis. There is no specific legal provision and procedure of post clearance audit. There is no legal procedure of bank guarantee release in customs law. Prevailing Customs Act is control driven. Like wise Export and Import Control Act, 1956 by name is control oriented. Control of export trade is reflected in Annex 7. This allows restricting exports freely and is subject to MOICS decision from time to time the goods to be included under the category of quantitative restrictions. There are many executive notifications which impose control in export trade. There are no serious and sincere provisions of trade facilitation especially in export sector. There are many legal provisions which are making hassles in export trade as explained earlier. For example, we can quote provisions of archives in the said Act which are directly adding one step of certification to Nepalese handicraft. The legal provisions of wildlife protection, plant quarantine, and narcotic control impose extra cost, time and efforts to the exporters. These provisions should be simple, automatic and transparent. All these legal provisions may be important in the national context but due to the lack of one window facilities of examining the exports document and exportable goods extra cost and time are incurred for completion of each formality. Industrial Enterprise Act, 1992 has the provision of all tax rebate to small and handicraft industries but in practice there is no such rebate because the language of the latest Income Tax Act has not transparently exempted the tax

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to them according to the interpretation of tax administrators. There is arbitration law but the time consuming legal procedures to settle disputes are being major constraints. G. Miscellaneous constraints

Besides above tariff constraints non tariff barriers add additional costs to exporters. Plant and animal quarantine certificates are needed to get permits to enter goods into India while exporting agricultural products from Nepal. The process of getting such certificate is very lengthy and involves extra cost to the exporters of Nepal. Nepalese exports have to face many non tariff barriers at exit points thereby losing competitiveness. Most of her trading partners have been levying antidumping and countervailing duties. India has fixed certain import quotas as mentioned earlier. There are problems of refund of excise and other taxes on export under barter system. Nepal has been conducting barter trade with Tibet historically. Even in barter trade excise refund should be simplified along with other refund schemes. Royalties on forest resources and mining are causing extra cost to some industries using such products as raw materials, for example, timber based handicraft products. Gold and silver jewelleries are exported outside but there is no formal records and incentives to the exporters. Nepal's agriculture policy and policy on herbs and forest and minerals products mention incentives in exporting these products which do not cover by our taxation acts. H. Prospects of tax policy reform

In Nepalese foreign trade regime there are many constraints and hurdles both policy and procedural wise on export promotion as mentioned earlier. Therefore, there are prospects of policy and procedure reforms too. In the context of Nepal's accession to WTO, many reforms are supposed to be introduced on taxation policy. Many developing and developed countries charge zero rate tariff on export or implement other tax exemption schemes to accelerate exports. Ironically after the expiry of MFA, the international market of garment has became more competitive to Nepal as mentioned earlier. Small economy like Nepal may suffer due to the high costs to compete with large economies. Keeping this in view, there is prospect of tax policy reform which includes reform in tax rates and in procedures as described in this paper. Specifically it is observed that there is scope to reform income tax, customs duty and local taxes. There is also prospect of increasing factor's productivity in Nepalese economy because at present the labor productivity is very low. Land, capital and entrepreneurship are also bearing low productive efficiency. Inadequate incentives to acquire new technology, poor export infrastructure and unfriendly business climate are responsible factors for low competitiveness of Nepalese product in international market. Therefore, there is a need of policy reform particularly in the above three areas.

CHAPTER IV ANALYSIS OF PRIMARY DATA AND COMPARISON OF EXPORT INCENTIVES IN NEIGHBORING COUNTRIES A. Analysis of the responses from stakeholders

During the course of study twenty six questions were circulated to the representatives of different commodity associations, FNCCI, NCC and big exporters. Questionnaires were distributed to 57 private sector persons and organizations giving almost three weeks time. Only 31 agencies returned the questionnaire in due date. Questionnaires were also distributed to a dozen of government policy makers of MOF and MOICS. There were different types of questions and the responses also differ accordingly.

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1. Responses on major constraints: On the question of identifying major constraints to enter into international market to Nepalese products the expensive banking service to exporters as major constraints got highest priority expressing 20.1 percent score (average score out of 700 marks). Second priority was given to procedural hassles as a constraint by providing 16.1 percent score to it. Third priority was placed to the insufficiency of government facilities. The actual picture is given in the following pie chart.

Response on Major Constraints

Expensive banking service , 20.1%

Insufficient facility , 13.9% Insufficient efforts, 12.4%

Heavy transit cost, 12.9% Procedural hassles, 16.1%

High cost of production, 11.9% Lack of knowledge of market, 12.7%

2. Major way out for export promotion: The suggestions were demanded from the stakeholders in question second. On this issue the highest priority was given to make international trade open and restriction free by providing 24.8 percent score (average score out of 600 marks). Second priority was given to increasing level of government services by giving 22.7 percent marks. Third priority was placed to tax rebates by providing 15.5 percent marks to that issue. 3. On the sufficiency of Industrial Enterprises Act, 1992: On this issue 36.67 percent said it was still relevant in the present context where as 30 percent said that there was need to amend the provisions of the Act and 20 percent of the respondent in favor of increasing facilities. The details of responses is shown in pie chart.
On the Sufficiency of Industrial Enterprises Act 1992

Do not know 13%

Relevant to present context 37%

Amend provisions 30% Need to increase provisions 20%

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4. On the issue of tax reform: With regard to tax reform 46.67 percent of the respondents suggested income tax reform and 30 percent gave their opinion on customs duty reform where as 20 percent suggested reform on VAT. 5. On the issue of customs reform: On this issue there were five hundred marks to each reform totaling 5. The respondent placed high priority by giving 24.4 percent marks on providing bank guarantee facilities where as they put in second priority to administrative reform in customs by providing 22.4 percent scores to it. They gave third priority to bonded warehouse facilities. On bank guarantee 71 percent of respondents suggested that it should be provided to all export oriented industries not only to the selected industries and 19.35 percent were of the opinion of providing only to those exporting more than 60 percent of their products. On the issue of export customs tariff 55.17 percent expressed their views to reduce it to make Nepalese product competitive whereas 27.59 percent said present export tariff is sufficient. 6. On the question of income tax reform: On the issue of income tax whether it is making Nepalese export less competitive or not, 77.42 percent of the respondents accept that income tax provisions are making Nepalese export less competitive in International market and it should be reformed. On the basis of taxation on export earning 53.33 percent responded that the basis of taxation should be profit where as 26.67 percent were of the opinion that income tax should be on turnover basis. Respondents of the garment, carpet, pashmina and handicraft sectors have suggested the income tax on turnover basis. In providing the response on question of income tax rate 78.57 percent gave their opinion of levying income tax at the rate not exceeding 5 to 10 percent and 17.66 percent were in favor of zero rate of income tax. The detail of responses on basis of income tax is shown below.
On the Question of Income Tax Reform

Optional 20%

Basis of turnover 27%

Basis of income 53%

7. On the question of local level tax: On the issue of local tax on export 73.33 percent opposed the local tax and suggested to remove it because it was affecting the export badly whereas 16.67 percent of the respondent were in favor of slight reform on local taxes and 10 percent were in favor of reducing rate of local level tax.

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On the Question of Local Level Taxes

Reform 17%

Reduce 10%

Remove 73%

8. On the question of controlling unauthorized trade: On this issue 46.43 percent of the respondent said there should be strong physical control in border area where as 28.57 percent were in favor of adjustment of tariff rate with neighboring countries and 25 percent were in favor of administrative reform.
On the Question of Controlling Unauthorized Trade

Admin. Capacity 25% Border control 46%

Tariff adjustment 29%

9. Miscellaneous responses: On VAT 38.71 percent demanded bank guarantee facilities to all export oriented industries on import of raw materials and 35.48 percent suggested to simplify VAT refund procedures. On the question of excise 69.23 percent were in favor of the existing policies but they suggested the reform in administrative process. On the question of royalty and registration fee 35.71 percent showed their ignorance about royalty and registration fee whereas 28.57 percent said that royalty and registration fee is not affecting industry negatively but it should be according to commodity and 25 percent were against it. On the concept of EPZ and APZ 53.33 percent of respondents supported it because in their opinion the concept, if implemented, properly will enhance exports.

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On the question of duty draw back system 38.71 percent supported the policy and demanded reform on procedure. 32 percent were of the opinion of duty refund at custom point on flat rate. On the question of reform on facilities to deemed export and intermediate goods 48 percent suggested to provide bank guarantee to import of the raw materials of intermediate products. 24 percent suggested refund after sale to the export house. On the question of barter system, 68.81 percent said the policy as such is good need administrative reform whereas 27.27 percent of the respondent opposed present foreign exchange payment system in place of barter system. On the question of facilities to export carried out by others than industries, 76.67 percent expressed their view that the same facilities should be provided to other exporters too whereas 16.67 percent in favor of partial facilities. Same questionnaires were also circulated to about a dozen concerning policy level officials of government agencies. Only few officials gave responses. On the question of identification of constraints, high priority was given to lack of sufficient facilities to exporters and they also recommended increasing level of government service. On the question of sufficiency of Industrial Enterprises Act, they were in favor of reform in its provisions. On bank guarantee reform, they suggested that the facilities should be provided to all export oriented industries. On the question of rate of income tax, they said that there should be zero rates. On the basis of levying income tax, most of them said it should be levied on the basis of income and profit. On the question of VAT, they suggested to simplify refund process. Likewise on the question of registration fee and royalty they were in favor of removal at least for export oriented industries. To the concept of EPZ and APZ, they said that such concept will accelerate exports. On customs tariff reforms, they said it should be reduced to make competitive export. On the question of controlling unauthorized trade they gave priority to physical control in border and increase in administrative capacity. On the question of local tax affecting the exports, they expressed that it should be removed. On barter system, they said that it was good but few were in favor of payment of foreign currencies in place of barter system. On the question of facilities to the exporters other than industries, they said it should be provided to all without discrimination. Thus in many cases there is consensus among private sectors and government sectors responses which is heartening to the consultant and probably other stakeholders. The response sheet on questionnaires is given in annex 8. B. Summary of incentives given in neighboring countries

All neighboring countries of this region have promoted their exports in different ways. Bangladesh has provided many attractive export incentives to their export oriented industries and traders too. Likewise, India and Pakistan have given many packages of export incentives. Pakistan has provided soft loan to their direct and indirect export at the interest rate of 8 percent. Pakistani central Bank reimburses the interest loss to commercial banks. Likewise, Bangladesh also provides pre-export and post export loan to exporters in cheaper interest rates. There are specified duty draw back facilities in India. Soft bank loan, income tax rebate and simplified procedures are known as major facilities in these countries. Indian budget 2005 has made provision of development budget to export oriented textile industries keeping in view with the expiry of multi fiber agreement.

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Nepal also has been providing lower income tax rate of 20 percent for export oriented industries. Export tariff, VAT and Excise are exempted through duty draw back scheme and soft loan facilities are provided which does not seem to be implemented properly. However, Nepal's incentives scheme is not attractive comparing to neighboring countries schemes. There will be negative impact on attracting FDI with this situation. There is strong competition for FDI between Nepal and the neighboring states of India among others. These states provide various fiscal and financial incentives and India as a big market also is an incentive in itself. Therefore Nepal should keep this in mind that without investment exports cannot expand and FDI should be attracted for which exports incentives should be attractive than the present packages. The comparison of export incentives prevailing in these regions are given in Annex 9.

CHAPTER V PROSPECTS OF PUBLIC PRIVATE PARTNERSHIP FOR PROMOTING EXPORTS A. Public private partnership

Public Private Partnership (PPP) is a development model recognized by many countries in recent times which has also been promoted by UNDP in some less developed countries. Nepal is also a country where such program is under implementation. UNDP has been working on developing urban infrastructure with PPP. Example of other initiatives of HMG/N from their side is BOOT Ordinance which is specially designed to facilitate investment of private sector in infrastructure sector. The concept of PPP in the Tenth Five Year Plan (2002 2007) has appeared in several sectors intends particularly to contribute in the reduction of the poverty through increased employment by enhanced investment of private sector. PPP has been recently introduced in legal form. However, its coverage at present is limited. The potential sector for PPP is urban electricity distribution, urban drinking water, and solid waste management and road maintenance. The development of these sectors through PPP is likely to contribute to the export sector as well. There is no doubt regarding merits of PPP development in promotional activities relating to export sector. Since the initiation of the participation of the private sector, noticeable achievements have been made in the field of health, education and transportation. Nepal's market oriented economic reform programs aim to make private sector participation more active in economic decision making, development of exportable products, investment in infrastructure development projects could greatly assist in exports growth. Thus the PPP is to be instrumental to support export led strategies in future. B. Present status and perspective

In export sector, government has formed various institutions with representatives from private sector to take decisions on policy issues. Carpets and garments are two important export items. Government has formed institutional mechanisms to take policy decisions for the development and promotion of these products. The institutions are Carpet and Wool Development Board and Readymade Garment Export Promotion Committee. Both are well represented by senior government officials and private sector organizations and imminent persons from private sector. In the same way, the high level export promotion committee under the chairmanship of the MOICS with functions to formulate national policies for the development of export is also represented by important private and public institutions. Likewise, the TPC is a government sponsored non profit making body, and focal point organization for the promotion of export trade of Nepal. The board of the centre which is a decision making body has been constituted with the representative from private sector institutions and the imminent persons. Suggestions are also received from RAC every year

20

before the budget speech with representative from the private sector to incorporate their concern in the budget of HMG/N. The list of suggestions of RAC is given in annex 10. TPC and EPC have not been able to make any substantial contribution to attain their goals other than arranging a few regular activities. Over the years, the role of the private sector has increased whereas the contribution from related government agencies has not been encouraging as expected. The export promotion is a difficult task and achieving the export promotion goal need serious initiatives from government and the private sector. Expected activities of the government and the private sector under PPP model could be as follows: From government perspective: The role of the government is to create an enabling environment under which the private sector feels comfortable to undertake export promotional activities. The government should encourage the Nepalese foreign missions abroad to be involved in economic diplomatic activities. The government should make simple and export friendly rules and regulations. The formalities to be fulfilled by the exporters to complete export procedures should be minimized and made transparent. Further, export promotional activities to be undertaken by the exporters could be supplemented by providing necessary assistance by the government. Likewise the government is responsible to play an active role for obtaining preferential entry of Nepalese products through bilateral, regional and multilateral trading arrangements capitalizing the least developed status of the country. Likewise the Govt's role for further streamlining of the transit procedures and availability of infrastructure facilities at the port at the concessional rates with the transit countries in the context of the landlocked position of the country is crucial. Possible policy reform is made in the computation of income tax and other taxes and the modality of the payment of the income tax and other taxes be made simple and transparent. The actions like availability of the finance without fixed collateral base, cheaper interest rate and easy allocation of foreign exchange for export promotion activities abroad, encourages private financing from international market for export related activities and provides special incentives to encourage unutilized remittance towards export related activities. From private sector perspective: Warehouse facilities at the major export points as well as in the port of Haldia are still inadequate where there is scope for private sector investment. Market promotion activities carried out by private sector at present are not sufficient and effective. Regular participation in international trade fairs for marketing of exports of existing and potential products and initiative to diversify the markets of these products are the regular activities of the private sector. Private sector should invest in developing new products based on local raw materials instead of assembling type industry. Last but not on least, development of export oriented industries wherein the country has comparative advantages by attracting foreign investment and technology is the topmost requirement for export promotion for which only private sector should play a proactive role. Private sector involvement in the establishment of export processing zones, construction of quality testing laboratories at the major export point will facilitate for export growth. After all export is private sector's business and the government can only facilitate through their policies. CHAPTER VI RECOMMENDATIONS FOR IMPROVEMENTS A. Recommendations Last one and half decade have witnessed liberalization policy in Nepal as well. Many efforts were made to promote export by providing different export incentives, relaxing export control and export duties. To lunch export drive government provided many types of refunds, rebates, exemptions and at times cash incentives. There is no account of the amount government has to lose in such schemes. In fact, export incentives should be commensurate with the results achieved through incentives. Nepal has been facing large trade deficit as mentioned earlier, therefore, the government has been emphasizing on export promotion. All

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efforts have marginal impact on export promotions so far. The trading community suggests increasing rebates on export duties and taxes every year. After consulting exporters, manufacturers and secondary data's the report was prepared. The draft report was presented in the seminar of stakeholders and suggestions are included. The report was presented in the Advisory Committee meeting and suggestions received are incorporated in the related paragraphs. The study would like to make the following recommendations to promote the export of existing and potential items. 1. Policy recommendation: Policies are known the directions for development and reforms. The well designed policies can address all hassles and improve the present status of export taxation. Following policy measures are suggested: a. Recommendation on investment policy: In Nepal FDI is much lower than other Asian least developed countries like Cambodia. There are many authorities to provide concession and approval to FDI in spite of declared one window system. Therefore, the policy to integrate formalities of foreign investment should be adopted. For this following policy improvements are recommended: Revisit the FDI policy in medium term Ensure investment security to the investors especially for export oriented industries Redirect FDI towards new product development for exports. b. Recommendation on lending policy: It is observed than commercial banks are enthusiastic to finance in trading sector rather than product development. For example generally banking sector does not give priority to finance industry comparing to trading. The attitude of banking sector should be changed. They should develop mechanism for loan safety and promotional loan to export. Following measures are recommended: Revisit lending policy especially for product development Professional supervision and monitoring of loans Provision of soft loan to exporters. Minimize spread rate in lending to export oriented industries. c. Recommendation on duty structures: Tariffs are levied on specifics or ad valorem basis in Nepal. Tariff structure has important implications on exports. Nepal's present import tariff structures leaving some exceptions reveals that there is high tariff on final product where as there is lower rate of duty on raw material and auxiliary raw materials of the industries. If the industries are export oriented exporters who pay tariff on raw materials get duty refund after export. There is export duty ranging from 0.5 to 8 percent. Revenue collection is not the main purpose of export duty. The main purpose of levying export duties is to discourage environment degradation, to ensure food security and check trade diversion to neighboring countries. At present direct export duty is attracted on some products which are generally exported to India and Tibet. The tariff rate should be restructured to ensure: To enhance investment in export oriented industries To make export incentives commensurate with export earning To levy import duty on industrial raw materials and auxiliary raw materials less than finished goods imported. To increase competitiveness of Nepalese product in international market To adjust the tariff in line with the changes in neighboring countries In view of the above objectives the tariff rate should be redesigned. The duty rate should be finalized after comprehensive exercise and cost benefit analysis in terms of export and import. If some compulsions are there for the country to impose export tax on some goods for example to protect environmental degradation, they should be conceded. Export duty on vegetable ghee was imposed before 2002 while its quota was not fixed by India. As quota has been fixed now it is hard to justify it. Similarly all those items attracting export duty should be reexamined and the list should be minimized. The present revenue amount from export tariff is low with the total contribution of only 6 percent on total customs revenue. In

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fact revenue neutral or zero tariff rates on export is recommended which is compatible with WTO rules. The revenue loss from such steps can be recovered by strengthening customs controls measures in border area. d. Recommendation on income tax rebate: Income tax is levied on profit whether it is earned by export or import. Previously income tax used to be levied on the basis of turnover on export. It was removed by Income Tax Act, 2001. Now all incomes are kept in the same basket and tax is levied on the basis of profit on total income. Producers of any country take care of total factor productivity that is land, labor, capital and entrepreneurship. Many countries provide incentives to support the exporters to compete in international market. Although majority of the stakeholders suggested the basis of income tax should be profit and some of them said the basis should be optional or turnover. Under the circumstances keeping in view the responses the expert came in conclusion that the basis of income tax should be chosen by exporters optionally and it should not be altered within five years. Article 15 (Ka) of IEA has been repealed by the amendment of Income Tax Act in Finance Ordinance 2062. This amendment has resulted in the withdrawal of income tax exemption given under the earlier act. Industrialist and traders anticipate that their production and export will be discouraged by this amendment. Finance Ordinance 2062 made provisions to levy only 75 percent of reduced rate of 20 percent income tax to export earnings. It is still not enough to be competitive to them in the international market. The following suggestions are made: Levy 1.25 percent turnover tax on export earning at the point of exportation for five years in place of the present rate. Exporters may be given option to comply the new recommendation or the existing rate. Exempt 50 percent of taxable income from export and levy tax at present rate in the long run. Or levy reduce tax rate to the income from export. Make provisions of allowing expenses to further development of new product for export. Tax administration should be transparent, non-corrupt and hassle free by improving the administrative system. Relate tax rebate with employment generation product development, RND, use of local raw materials and value addition. Recent amendment on income tax to repeal provision of IEA Article 15 (Ka) needs to be reconsidered in a way to facilitate small, cottage and handicraft industries. The amount of income tax raised from exports today will be well compensated from 1.25 percent turn over tax on export at exit points. Alternatively income tax rebate can also be provided on selected items of export of importance to the country by developing some criteria for example high value addition, creating high employment opportunities and using local raw materials etc. e. Recommendation on local taxes: Local taxes play role of impediments on export promotion. Among them local level municipal tax and district level export taxes are major cost escalating factors. In the course of discussion with stakeholders they said a consignment from Nepalgunj has to pay around Rs. 7,000/- to exit from Kakarbhitta. Therefore, the study keeping in view the discussion with stakeholders following suggestions are given: Removal of the provision of VDC, municipality and district level local export taxes

from Local Self-Governance Act on national exports.


Provisions of refund of such taxes if levied on the movement of goods from the

factory or collection center up to the export point. As this tax is collected by local bodies refund mechanism should be different than other government taxes. The tax levied on exports by local bodies can be refunded by the fund of local development tax which is collected by customs at import points.

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f. Recommendations on product diversification: Tenth Plan (2002-2007) has emphasized to use the opportunity that has emerged in the area of hydropower, computer software, and labor markets. Similarly, in view of Nepal's rich bio-diversity situation, small scale industries based on local agro-forest resources are of prime importance. Some items of exports such as agro-forest resource which have high value like different forms of spices, floriculture, sericulture, honey, buck-wheat, Niger seeds, fresh vegetable and seeds, fruits (apple and orange), tea and coffee, semi-precious stones could be potential exportable products. They will not demand extra land, labor and new technology. At the same time some studies need to establish the forward and backward linkages. The following activities should be started as soon as possible.
Already identified and feasible projects should be negotiated with foreign investors

particularly in water resources and software.


IT Park under construction should be operational immediately. Nepal should provide vocational or effective training for laborers who are looking for

job in international market.


Market study should be done for promoting exports of new agro-forest commodities Economic diplomacy should be strengthening. Investment should be promoted from national entrepreneurs particularly for agro-

based product development.


Agro forest and minerals products should be identified and prepared up-to-date

reports of each products.


Provide special privilege in tax particularly for new product exported to new market.

2. Recommendation on administration and procedural improvement: Most of the constraints are related with administrative procedures. The efficient, sincere, committed and non-corrupt administrative setup can address most of the constraints. The following measures are recommended. a. Recommendations on simplification of duty draw back procedures: Import duty already paid on the raw materials and auxiliary raw materials under the duty refund scheme is refunded to exporters. However, step wise procedure should be redesigned and improved. Similarly, VAT and excise duty if paid is also included on duty draw back scheme. In Nepal the refund performance is very poor. The refund procedure is lengthy and cumbersome. Many government agencies are involved in duty refund decision and one window system is not performing well. Therefore, the following activities should be immediately started:
Settlements of old duty draw back cases within 6 months. Introduce the duty suspension scheme i.e. pass book system make simple and

predictable and provide it to all export oriented industries.


Develop a mechanism to include all exporters through export houses not necessarily

producers. Small producers in the system who by virtue of being below threshold are not registered in VAT have not been able to get VAT refund. They are working in handicraft, pashmina, carpet and garment industries. These small producers should be benefited from the refund scheme. Payment of duty draw back through commercial banks on the basis of the mechanism lay down by NRB. Design simple procedures and format to get duty draw back. Make effective provisions to implement deemed export as stipulated in Industrial Enterprises Act. Provide duty rebate to those enterprises and producers selling their products to export houses. Provide flat rate refund based on input and output ratio (coefficient) at F.O.B. price to ensure the benefit to small producers and flat rate should differ from product to product. Duty on packaging materials of export item should be treated as auxiliary raw materials of products for export.

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Provide duty draw back in flat rate based on product to product.

b. Recommendations on bank guarantee release and bonded warehouse: Present system of bonded warehouse is covered by bank guarantee. The exporters under this facility use their own warehouses to store in and out the stock of raw material according to their need. Bank guarantee is released after submission of export certificates and related documents. To simplify the bank guarantee release system following reforms are suggested:

Develop private sector warehouse on the basis of BOOT Provide bonded facilities to all export oriented industries. Develop systems of supervision on warehouses Specify documents needed to release the bank guarantee. Design formats as per international practice Make bank guarantee release predictable and transparent Automation of bank guarantees in each customs points and exchange of information Make provision of online release of bank guarantees. Provide the bonded warehouse facilities to imported intermediary products if sold to export orient industries. Provide duty suspension facilities to domestically produced raw material & intermediary raw material. Encourage the use of revolving bank guarantee to avoid working capital blockade. The procedures of paying guaranteed duties by banks to customs should be simplified and predictable. There should be time frame for bank guarantee release.

c. Recommendation on export infrastructure and logistics: Nepalese exports have to bear heavy pre-shipment transportation and handling costs. Transit cost and freight are very high and critical to the Nepalese exporters to be internationally competitive. Therefore, for export logistics and infrastructure development following actions are suggested:
Establish EPZ, SEZ and APZ for high value and low weight products near

international airport and low value and heavy weight type of items near land border. Encourage private sector to establish export house. Provide soft loan to export related activities. Provide fast track clearance to exports. Provide transport subsidies to export of fresh fruits, cut flowers and vegetables and other non traditional products. The private sector has to be able to utilize fully ICD facilities particularly Birgunj and Fulbari-Banglaband alternative land route for transit. The government has to take up this matter including double checking of containers at Indian border and Kolkotta. Update Transit Treaty with India which has to be renewed in near future in Nepal's favor. Make provision of transit cargo house. Develop business accounting system with ICAN modal. Nepal may explore to accede in convention on the international transport of goods under cover of TIR Convention, 1975 amended as of May 12, 2002.

3. Recommendation on institutional development: Trade liberalization alone cannot enhance exports of national products. Therefore, trade liberalizations should be followed by well designed institutional setup to implement the reform program. Following are suggested: Develop a cell in TPC or in the proposed unified organization to collect information on import policy of countries which may have market for our potential new products and introduce marketing activities in such destinations or countries. Get maximum benefit of preferential entry through EBA in EU. Negotiate to revise Trade Treaty with India to promote Nepalese products in Indian market and ready made garments in US markets

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Specify procedures and agencies responsible for providing concessions, approvals

and permissions to the investors and exporters and make effective one window system. Negotiate efficiently with WTO, SAARC and BIMSTEC to get more facilities as a least developed country. Make provision to establish export and import bank (Exim Bank). Make one effective trade promotion organization instead of several non-functioning organizations. 4. Legal recommendations: There are many legal constraints which should be addressed in Nepal. There are different provisions of restrictions and controls in different acts. Following recommendation are made to address the legal constraints. Revise Labor Act making it industry friendly and compatible with employment contract law. Regulate barter system of trade with Tibet (Autonomous region of PR China) and gradually encourage to channel through banking system. Revise Foreign Investment and Technology Act to make it FDI friendly. Negotiate to revise Trade Treaty with India Introduce bankruptcy law. Make provision of post clearance audit in Customs Act. Revise Export Import Control Act. Revise Industrial Enterprises Act. Revisit arbitration laws and regulations for fast track dispute settlement of industries. 5. Miscellaneous recommendations: There are different factors that contribute low productivity and high price in Nepalese industries. There are inadequacies of incentives, cumbersome procedure, unpredictable business climate, poor infrastructures and unproductive labor force and low entrepreneur capacity with rival attitude which are resulting to high costs. The study suggests following actions to reduce such anomalies:
Provide technical training to Nepalese labor. Control informal trade seriously with neighboring countries, so that genuine exporters

are not hurt.


Develop efficiencies in factors of productions such as land, capital and labor because

such factors force prices up.


Permission of sale of goods rejected for exportation after the payment of revenue Reduce or even subsidize air freight for export of fruits, fresh vegetables and cut

flowers significantly and concessional rate to other export items.


Reduction of duties and taxes in machinery for research. Increase ceiling of annual sample export. Provision of local fare and incentive to participate in international fares to promote

exports.
Increase use of local raw materials. E-commerce should be incorporated in legal framework especially software export

through internet should be effectively promoted in export activities.


Separate package of integrated facilities to export oriented industries established in

remote area is advised.


PPP should be strengthened making private sector pro-active and responsible to

invest more on export oriented sector.


Revisit cross exchange rate with Indian currency to facilitate export. Provide other alternate mode of payment beside L/C because in some cases

services charges of export L/C is very high.


To reduce operational time and cost at customs. To abolish any type of syndicate in customs point.

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Plant quarantine and chemical testing certification arrangement should be initiated

with India. Mutual recognition of standards of both the countries should be fixed and entertained at the field level. At least 20 percent ceiling of value addition should be specify to enjoy export incentives. Similar a separate study on exports of services is recommended as they are very important to our economy. Thus the study makes above recommendations to address constraints on export promotion. To make the recommendations operational, present study provides policy-action matrix which consists of constraints, policy improvements, activities, indicators, time frame and responsible agencies as mentioned in TOR. The policy action matrix is reflected in annex 1 (a). B. Conclusion

At macro level, there has been trade imbalance since a long time. Recently the remittance has become only remedy to meet the widening gap of balance of payments. Nepal has only one way out to boost up her export trade to correct her trade imbalances. There are many constraints relating to export promotion i.e. economic, tax policy, legal, institutional and procedural. At present, the international trade is developing in faster pace than before. The developing economies are weaker partners in the game of global market. They have to seek better opportunities in the midst of challenges. The present electronic development has made possible to the consumers of any country to order and supply the goods and services through the single click of his mouse. The fastest change in design, pattern and the taste of global consumers has also become challenge and opportunity for exporters. After all the constraints and challenges can be converted into opportunities if internal legal, policy and procedural constraints are addressed timely. All developed partners started e-commerce excluding least developed countries like Nepal. Therefore, Nepal should address immediately the constraints of export trade and reform policies to enter into diversified market with diversified product development plan. Being a land locked country Nepal has its own limitation regarding transit and transportation cost of particularly fresh fruits, vegetables and cut flowers etc. Nepal should develop packages for transport subsidies to reduce domestic and international transport cost. It may be noted that WTO agreement on agriculture does not restrict such type of transport cost reduction plan. All export incentives should be commensurate with export earning. Economic analysis should be conducted to find out the impact of incentives provided by ourselves and the impact of similar incentives given by neighboring countries should be taken into account in formulating our incentive packages.

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Annex 1 TERMS OF REFERENCE

The macroeconomic specialist will: (a) Conduct research on Status, Prospects and Constraints in Tax Policy for export promotion and prepare draft policy paper, Task details.

Review of present status, Identify prospects, Identify legal, economic and policy constraints, Hold meeting with the Government, private sector and other stakeholder to obtain consensus on policy recommendations, and develop action plains, Suggest policy improvement, Identify prospects for public-private partnership, Suggest policy-action matrix (a) policy improvements (b) activities (c) indicators and (d) responsible agencies, Submit draft report within 30 days from the date of assignment, Present the draft at the workshop organized by the Advisory Committee and EPN Focal Unit' Submit final report incorporating feedback from the workshop within 2 weeks of presentation at the workshop.

(b)

Assist MOF in organizing meetings, workshops, and seminars to review and discuss the findings of the reports, obtain consensus on policy recommendations, and develop action plans, Assist MOF in monitoring implementation of the action plans, Undertake other tasks as required by the steering committee and ADB, and Maintain strict accountability at all times as per contractual obligations and ensure timely delivery of policy papers.

(c) (d) (e)

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Annex 1 (a) Policy-Action Matrix S.N. A. 1 Constraints Policy Investment policy Policy improvement Activities Indicators Time frame Responsibl e agency MOICS, MOF

Revisit the policy of

Lending Policy

investment particularly FDI Ensure the safety of investment Revision of lending policy by commercial banks

Update FIT Act and Procedures Compare the facilities of FDI with

Increased in FDI at least

Medium term

neighboring countries
Draft new policy Revise present lending policy of

10 percent from present level Updated FIT Act


Increased in concession

Short term

commercial banks Make provision of pre-shipment and post shipment loan Make provision of soft loan
Make less differences in lending

on pre-shipment and post shipment loan


Loan at lowered rate

MOF, NRB, Commercial banks

Minimization of spread

and borrowing

rate Effective debt monitoring system 3 Export tariff


Restructuring export Analyze the present rates and try Export duty reduced at

Short term

MOF

tariff
Revisit income tax act

to make minimal or zero rate to make it revenue neutral


Redesign tax rate modality on

around 1% or zero level


Export income will be

Income tax

Short term

MOF

particularly on export earning

export earnings Provide and relate rebate on export earning with employment, development and R&D, use of local materials and value addition

taxed on turn over at the rate not exceeding 1.25% or Permanent 50% rebate on export earnings or special reduced tax rate

Long term Long term

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Differentiated tax rate for

Recent amendment on income tax

which repeals IEA article 15 (ka) needs to be reconsidered. 5 On local taxes


Ensure the exportable Discuss with local leaders to

items are free of all type of local taxes. If levied make provision of refund
Facilitate exporters and

create environment Create fund for refund from local tax levied on import by the government Prepare modality of refund
Specify areas of exportable

employment generation use of local raw materials and value addition. Small, cottage and handicraft industries encouraged Awareness created to make tax free export Fund created for refund Modality of refund finalized

Medium

Long term Short term Short term

MOLD, MOF

On product & market diversification

Increased new agro forest

Long term

foreign investors to develop new products

Evaluate the

performance of embassies on the basis of economic diplomacy to promote export

product development for foreign investment. Provide special tax rebate to those new products exported to new market. Fewer products with specialization. Stakeholders including the government might like to come out with a matrix of 10 countries and 10 products.
Select embassies for economic

products developed Potential hydro power projects developed New product encouraged.

MOICS, MOF, MOFA

Implemented export

Medium term

diplomacy specifically for exports


Develop liaison between exporters

and missions

oriented eco-diplomacy with India, China and developed countries Improved export activities in 10 potential areas through diplomatic mission Expanded export oriented eco-diplomacy in rest areas.
Negotiated in Nepal's

Revisit negotiation with

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international & regional organizations (WTO, SAFTA, BIMSTEC and EU)

Develop negotiation capability

interest

with bi-lateral and multi-lateral agencies Analyze benefit and cost of present treaties with bilateral countries Negotiate in Nepal's interest

B. 7

Administrative and procedural Duty draw Settlement of old cases back


Encourage the use of

Short out old cases within 6

100 % old cases settled

Short term

months Make quick decision and pay


Increased use of pass Create awareness to use pass

MOICS, MOF

Medium term

pass book
Duty refund through

book
Introduced refund through

book commercial bank


Draft format & procedural manual Specify rules and procedures

Short term

through separate study


Create adequate fund for refund Refund on flat rate which may Develop and

differ product to product


Develop operating manual of

strengthen export houses directives


Specify auxiliary raw

commercial bank on submitting authentic paper of export payment Prepare separate report Adequate fund created to refund Flat rate refund system introduced
Specified at least 5 export

Short term Medium Short term

export houses to get refunds materials


Packaging materials of export

houses within six months


Export cost reduced by

item should be treated as auxiliary raw material

exempting the duty of

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packaging. 8 Bonded ware house and bank guarantee release


Develop private and

public partnership on ware house development (BOOT) Provide bonded facility to all export oriented industries
Simplify bank

Provide duty draw back in flat rate Draft operating manual Make legal arrangements Simplify formalities/formats Specify revolving bank guarantee.

Draw back simplified Established export ware

Long term

houses at least in major customs points Short term

MOF, MOICS, NRB

Specify needed document to

Short term
All export oriented

guarantee release Bonded facility on VAT too. Recovery of guaranteed duties.


online dissemination of

release the bank guarantee at minimum. Provide bank guarantee for VAT Procedures should be simplified to pay guaranteed duty in time by bank
Make legal provision for

industries facilitated with bonded ware houses including VAT Reduction in number of defaulters
Reduced at least 25%

Long term Short term Short

bank guarantee and its release

automation of bank guarantee records and its release at. Computer networking with DOC/Airport/ local customs with bank guarantee program.

paper work
Targeted paper less bank

guarantee release by automation scheme Reduced in number of documents and time length of bank guarantee release.

C. 9

Export Infrastructure and logistics Export Make operational infrastructure export house concept and logistics constraints Simplify transit procedures with India and Bangladesh
Improvement in

Establish export houses Prepare operating manual for it

Specified 5 export houses Get specific operating

Short term

procedural manual
Revise Transit Treaty to facilitate Transit Treaty with India

Medium

MOICS, MOF, NRB, FNCCI, DOC, MLT, CAAN.

cargo in transit. Explore the benefit acceding in convention of international transport under cover of TIR

and Bangladesh revised. Benefit from the accession into the TIR convention

Medium

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customs infrastructure

(CARNET).
Fast track services Abolish any kind of syndicate at

provided at Customs.
Syndicate abolished Standardized business

Short term

customs Reduce time and cost at customs.


Harmonize business Develop business accounting

accounting system system in line with ICAN modal

Medium

accounting with international standard D. 10 Institutional Institutional Constraints

Establishment of trade

Study the need of all trade related

Amalgamated

Short term

facilitation committee focusing exports

committees Amalgamate all committees in a single trade facilitation committee


Create special cell to provide

unnecessary committees in a single one with high power. Short term

MOICS, MOF, NRB

Develop special cell as

focal point to provide export information including importing countries, import policy and tariff
Specify responsible

information or strengthen TPC with new role

Equipped information cell

to provide information to exporters

Established single agency with all

single agency to provide concessions to foreign investors Establishment of export /import bank E. 11 Legal Legal Constraints

power to provide concession to foreign investors.


Established an exim bank on

Single authority provides

one window service to foreign investors


Exim bank established to

public private partnership o Legislative reform


Make provision of extra tax rebate

meet financial deficiencies


Increase at least 3 new

Medium term

to those who export new product to new market

products per year

MOF, MOICS, MOLT

33

Revisit treaties with neighboring

Penetrate Indian, Tibetan

Long term

o Provision of fast track Arbitration Laws and Regulations

countries to penetrate their large markets Revise Labor Act making it industry friendly Update Industrial Enterprises Act Draft bankruptcy law to deal with insolvency. Make provision of post clearance audit in Customs Law Revise Export and Import Control Act to make export friendly Draft predictable and transparent investment policy followed by legal base Prepare investment manual

(Chinese) market with suitable negotiations Medium


Export friendly Labor Act

and other acts


Legal arrangement will be

Medium

commensurate with export promotion

Investment motivated by

Medium

manual
Fast track dispute

Long Term

Revise the laws and regulations to

settlement

provide fast track arbitration facilities. F. 12 Miscellaneous Miscellaneou Informal trade control s Constraints

Activate border patrolling Specify duties and responsibilities

Reduced informal trade by

Medium term Short

of different agencies controlling border points


Price lowering scheme Improve the cost of different

20% in each year Strengthen border patrolling


Reduced the cost of

MOF, MOHA, MOICS, FNCCI, NRB

in factor of production

factors of production Specify cost cut down schemes for export competitiveness
Draft working manual for internal

Long Medium

production
Reduced FOB price by

20%
Local and international

Short

fair promotion

and international fairs

34

Mitigation of transport

Identify risk of transport of

At least participate in 5

risk for fresh fruits, vegetables and cut flowers


PPP should be

different fresh products Specify the process of mitigating risk.


Exhibit commitment by both

promoted
Provisions of alternate

government and private sectors to promote exports.


Make L/C cheaper and make

regional and international trade fairs and 5 domestic fairs annually Reduced risk of transport of exportable fresh fruits, vegetables and cut flowers.
Committed govt. and

Short

Short

Short mode of payment


Revisit rate of

provision of alternate mode of payment


Change cross rate of exchange

private sector for export promotion


Export cost reduced by

Short

exchange
Plant quarantine and

with Indian currency


Initiate certification arrangement

efficient and alternate mode of payment


Nepalese currency will

Short

chemical testing certification arrangement Equalization of standard


Ceiling for value

with India
Quality control in equal footing

Medium

compete with hard currencies with neighboring countries


Value addition ceiling specify for Reduced quarantine

Medium Medium

hassles at the eleventh hour.


Standardization of

export incentive
Prepare ToR and assign study.

addition in exports Undertake separate similar study on export of services.

products.
At least 20 percent value

addition arrangement made. Study initiated and report prepared.

35

Annex - 2 (a) Exports of some major commodities to overseas countries F.Y. 2058/059 (2001/02) F.Y. 2059/060 (2002/03) Quantity Value Quantity Value 1 Woolen Carpet Sq.m 1,668,379 6,108,635 1,606,520 5,317,656 2 Readymade Garments Pcs. 32,527,652 7,752,296 45,854,972 11,613,749 3 Hides and Goatskin Sq. ft. 8,429,008 450,797 5,000,333 239,853 4 Tea M.T. 83.1 27,988 193.1 53,908 5 Essential Oils M.T. 4.0 4,283 3.3 8,004 6 Pulses (Lentils) M.T. 6,022 216,402 2,429 210,465 7 Cardamom (Large) M.T. 351 82,636 570 127,600 8 Sugar M.T. 9,169 386,206 9 Oil-cake & other solid residues M.T. 7,429 59,785 10 Handicrafts 282,770 377,944 11 Silverware & Jewellery 252,643 331,636 12 Woolen & Pashmina Goods 1,852,220 1,534,081 13 Towel 318,086 338,015 14 Nepalese Paper & Paper Products 249,134 269,169 15 Wooden Goods 38,005 33,690 16 Incense Sticks 21,599 25,136 17 Cotton sacks and bags 83,442 151,317 18 Micro Transformer 38,766 56,148 19 Others 629,534 847,113 Total 18,409,236 21,981,475 [Source: A Glimpse of Nepal's Foreign Trade (Statistical Presentation), Trade Promotion Center, 2004] S.N Commodities Unit Value in '000 Rs. F.Y. 2060/061 (2003/04) Quantity Value 1,648,918 5,461,301 38,994,326 9,552,544 6,627,864 286,117 1,002.2 106,897 6.2 22,935 7,590 294,554 1,111 228,963 9,250 404,165 4,497 45,560 427,189 321,569 1,473,675 249,393 348,482 46,810 26,985 150,509 59,443 1,434,570 20,941,661

36

Annex 2 (b) Exports of selected commodities to India Value in '000 Rs. S.N. Commodities F.Y. 2001/02 F.Y. 2002/03 F.Y. 2003/04 (2058/059) (2059/060) (2060/061) 1 Pulses 1,005,700 880,400 575,000 2 Ghee 60,000 54,600 36,600 3 Herbs 84,100 111,900 79,100 4 Ginger 207,900 315,400 263,500 5 Dried Ginger 80,500 108,400 73,000 6 Linseed 10,200 45,800 33,400 7 Cotton Seed 500 300 200 8 Fruits 6,100 2,400 700 9 Vegetables 25,700 43,000 17,000 10 Wheat Flour 44,400 7,100 32,200 11 Vegetable Ghee 7,081,400 3,812,300 2,959,000 12 Jute Goods 1,630,100 1,899,000 1,882,600 A. Hessian 44,700 44,200 143,500 B. Sackings 609,200 855,900 1,056,500 C. Twines 976,200 998,900 682,600 13 Live Animals 56,200 62,500 40,400 14 Rice bran Oil 90,600 210,000 194,700 15 Turpentine 40,500 24,700 15,700 16 Cinnamon 8,900 4,700 6,300 17 Cardamom 359,900 469,600 449,500 18 Catechu 180,400 145,400 159,500 19 Stone and Sand 104,600 189,500 140,400 20 Rosin 233,700 221,600 138,200 21 Brooms 56,700 102,700 65,300 22 Noodles 227,000 309,700 259,700 23 Biscuits 26,000 25,100 15,500 24 Marble Slab 23,000 28,600 36,900 25 Cattle Feeds 215,000 405,900 544,100 26 Brans 41,200 62,800 37,500 27 Oil Cakes 302,600 311,100 303,700 28 Hides and Skins 157,800 248,500 332,300 29 Tooth Paste 1,606,700 1,002,800 1,478,800 30 Polyester Yarn 1,070,400 656,900 1,114,500 31 Readymade Garments 213,500 399,200 626,200 32 Handicraft Goods 31,800 44,800 25,600 33 Vaneer Sheets 1,700 3,800 5,100 34 Toilet Soap 528,900 469,200 539,100 35 Chyawan Prass 262,600 525,900 36 Hazmola 320,800 217,200 289,900 37 Kachha 8,800 11,200 8,200 38 Iron Scrapes 19,400 7,000 3,700 39 Bristle 3,100 2,100 500 40 Others 11,527,800 12,986,900 18,460,700 Total 27,956,200 26,430,000 31,244,300 Note: Trade with India for the F.Y. 2003/04 is provisional. [Source: Nepal Rastra Bank, A Glimpse of Nepal's Foreign Trade (Statistical Presentation), Trade Promotion Center, 2004]

37

Annex 2 (c) Exports of some major commodities to Tibet S.N. 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 Commodities Handicraft Goods Textiles Aluminum Utensils Vegetable Ghee Incense Sticks Biscuits Brass Utensils Noodles Wheat flour Maida Limitation Jewellery Cosmetics Decoration Goods Rice Readymade Garments Chocolates Coffee Bitten rice Sponge Fruits Paints Tea Fruit Juice Others Total F.Y. 2001/02 15,381 9,615 138,397 203,224 17,434 14,417 21,588 21,354 84,656 3,508 13,915 20,939 1,120 4,407 11,348 5,412 2,726 1,580 268,566 161,765 1,021,352 F.Y. 2002/03 38,584 180,187 183,583 196,173 35,874 36,501 101,362 122,852 73,370 27,994 45,266 2,330 10,605 11,896 11,206 14,999 33,337 32,102 9,430 2,412 26,344 429,584 1,599,647 F.Y. 2003/04 223,188 245,905 181,500 139,810 99,073 97,351 91,494 62,253 57,878 48,047 46,953 46,652 40,848 40,146 33,745 31,690 18,073 16,146 16,823 14,958 14,922 9,461 654,737 2,230,653

38

Annex- 3 List of exportable and potential export products of Nepal. 1. Animals/Poultry & Diary Products. 2. Plants and Cut Flower 3. Vegetable, Fruits & Fruit Products 4. Tea/Spices 5. Cereals & Cereal Preparation 6. Sugar, Sugar Preparation, Honey 7. Oil Seeds, Oil & Fat 8. Food Preparation 9. Beverages 10. Feeding Stuffs, Cake and Meals 11. Tobacco & Tobacco Manufactures 12. Crude Minerals 13. Animal and Vegetable Products 14. Essential Oils and Perfumery Products 15. Leather, Leather Manufactures 16. Rubber Manufactures 17. Wood Manufactures 18. Papers, Board and Manufactures 19. Footwear 20. Mineral Products 21. Metal Manufactures, Including Handicrafts 22. Power Generating Sets and Accessories 23. Furniture and Parts 24. Pulp & Waste Products 25. Fibres, Yarns & Textiles 26. Apparels & Clothing Accessories 27. Non Apparel Textile Articles 28. Miscellaneous Manufactured Article Including Books & Giftware.

39

Annex 4 Basis of local level tax (example) Related to Rule 207 of Local Self-Governance Act The DDC can levy within the minimum and maximum limit at the following rate decided by DDC Council on export of the product of their own district.

Minimum 1. Natural wool & like items 2. Turpentine 3. Forest products 4. Bamboo 5. The rate will be half for herbs Rs. 0.5/kg Rs. 0.25/kg Rs. 1.00/cart Rs. 0.20/piece

Maximum Rs. 0.10/kg Rs. 0.50/kg Rs. 100/cart Rs. 0.50/piece

6. Others minerals according to the rate decided by district level RAC.

Note: Government is collecting 1.5% LDT in import point and distributing it to local municipalities.

40

Annex 5 Export Tariff Structure SN 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 Hscode 150710 151110 151311 151321 151610 151710 170310 230220 250510 251621 251621 251621 251621 320300 320300 391510 391610 391710 391810 392000 392100 440110 440310 440410 440500 Description of goods Soya bean oil crude or refined Palm crude or other of 90 coconut crude and other of 90 palm kernel crude and others of 29 animal fats and veg. fats of 20 margarine excluding liquid & .90 crude molasses and others brand of rice an others & .90 silica sand and others .10 crushed stone up to 2 inches .20 crushed stone above 2 inches .30 boulders .90 mixture sand and pebbles .10 cutch .90 catechu .20.30.90 waste scrape of plastic .20&.90 plastics profiles To .40 plastics pipe fittings &.90 floor covering of plastic other plate sheet of plastics 3926and sub heads plastics ware etc to .21.22.30 fuel wood To .99 wood in rough or square to20 hoop wood poles, trimmed worked suitable for manufacture to4407.99 wood wool fantas sliced 2058/59 5% 5% 2% 2059/60 10% 10% 1% Export tariff rates 2060/61 10% 10% 1.5%

5% Rs. 100/cum Rs. 50/ cum Rs. 100/ cum Rs. 300/ cum Rs. 100/ cum Rs. 2/kg Rs.5/kg 4% 4% 4% 4% 4% 4% 200% 200% 200% 200%

Rs. 0.25/ kg Rs. 0.25/ kg Rs. 100/cum Rs. 50/ cum Rs. 100/ cum Rs. 300/ cum Rs. 100/ cum Rs. 2/kg Rs.5/kg 2% 2% 2% 2% 2% 2% 200% 200% 200% 200%

Rs. 0.25/ kg Rs. 0.25/ kg Rs. 100/cum Rs. 50/ cum Rs. 100/cum Rs. 300/cum Rs. 100/cum Rs.2/kg Rs.5/kg 3% 3% 3% 3% 3% 3% 200% 200% 200% 200%

2061/62 10% 10% 1% 10% 10% 10% Rs. 0.25/ kg Rs. 0.25/ kg Rs. 100/cum Rs. 50/ cum Rs. 100/cum Rs. 300/cum Rs. 100/cum Rs.2/kg Rs.5/kg 2% 2% 2% 2% 2% 2% 200% 200% 200% 200%

2062/63 8% 8% 0.5% 8% 8% 8% Rs. 0.25/ kg Rs. 0.25/ kg Rs. 100/cum Rs. 100/cum Rs. 100/cum Rs. 300/cum Rs. 100/cum Rs.2/kg Rs.5/kg 1% 1% 1% 1% 1% 1% 200% 200% 200% 200%

41

26 27 28 29 30 31 32 33 34

440800 540231 550931 721011 721113 721210 730410 730610 940370

to .90 sheets for veneering for plywood to.69 synthetic filament yarn 10 to 69.90 yarn stable fiber synthetic to90 flat rolled iron product above 600mm to90 flat rolled iron less than 600 mm to 60 flat rolled iron coated less 600mm to90,730511to90 tubes pipe & profile to90&730711to99 other pipe fittings other furniture of plastics

70% 2% 0.5% 2% 2% 2% 2% 2% 4%

70% 1% 0.5% 1% 1% 1% 1% 1% 2%

70% 1.5% 0.75% 1.5% 1.5% 1.5% 1.5% 1.5% 3%

70% 1% 0.5% 0.5% 0.5% 0.5% 1% 1% 2%

70% 0.5% 0.5% 0.5% 0.5% 0.5% 0.5% 0.5% 1%

42

Annex 6 Prevailing income tax rate and slabs

1. T. D. S. in payment to Contractor 2. T. D. S. in payment to Consultants 3. T. D. S. in Salary and Wages 4. T. D. S. on Interest earning Individual Entity

1.5% 15% 15%

6% 15%

5. Dividends 6. Tax in Income of Financial sector at the rate of 30% (31.5%)

5%

Other Corporate sector at the rate of 25% (26.5%) Export Oriented Industries at the rate of 20% (Only 75% of the rate is levied)

Tax exemption in Slab: Individual income of Rs. 1, 00, 000 is exempted from tax. The income up to Rs. 1, 25, 000 tax is after exemption @ 15% to the individual. The income above Rs. 1, 25, 000 up to Rs. 1, 75, 000 tax is Rs. 11,250 The income above Rs. 1, 75, 000 tax is @ 25% income tax Exemption to the couple up to Rs. 1, 25, 000 The income up to Rs. 1, 75, 000 tax is @ 15% after exemption. The income above 1, 75, 000 up to 2, 00, 000 tax is Rs. 11, 250 The income above Rs. 2, 00, 000 tax is @ 25% No exemption in corporate sectors.

Note: The above rates are based on Finance Ordinance 2062.

43

Annex 7 List of prohibited, restricted and freely tradable exports as mentioned in Export Import Control Act, 1956 Products prohibited for export: 1. Articles of Archeological and Religious Importance:
National and Foreign coins of archeological value, Idols of god and goddess, palm leave inscription (Tad Patra), plant leave inscription

(Bhoj Patra),
Scroll (Thanka Paintings) of historical importance.

2. Conserve Wildlife and related Articles:


Wild animals, Bile and any part of wild animals, Musk Snake skin, lizard skin, Cow and ox.

3. Drugs: Marijuana, opium, hashish (as defined in the Single Convention on Narcotics 1961) 4. Valuable Metals: Valuable metals including Gold, Silver (except ornaments) and Jewelleries (except those allowed under Bag and Baggage Rules). 5. Articles of Industrial Importance:
Explosive materials and related fuse or materials needed for fuse. Materials used in the production of arms and ammunition.

6. Industrial Raw Materials: Raw hides and skin (including dry salted)
Raw wool, All imported raw materials, parts and capital goods, Raw Silk (export import permitted only up to 100 kg without L/C).

However, import of similar materials is permitted as replaced if the purpose of the import is not met. And, if the materials are not consumed in Nepal and are required to be send back, against repatriation of foreign exchange paid for imports, customs duties and other taxes incurred for import and export may be refunded. 7. Other Products:
Mamira Log and Timber

8. Exports to India: All goods imported form countries other than India (except those allowed under Bag and Baggage Rules).

44

Products under Quantitative Restrictions: Products as notified by His Majestys Government in the Nepal Gazette from time to time:
Rice.

Products allowed for Free Exports: All products other than banned ones and which are under quantitative restrictions. Notes: a. The Ministry of Commerce will decide from time to time the goods to be included under the category of quantitative restrictions and volume of their exports. b. The ministry of Commerce will interpret as to which of the products listed above will be permitted to export.

45

Annex 8 Response sheet of stakeholders 1. What are the major constraints of Out of 700 international market for Nepalese product? number average score 1 Insufficient facilities to export 97 2 Insufficient efforts of the government for 87 promotion 3 High cost of production 83 4 Lack of Knowledge of international market 89 5 Procedural hassles 113 6 Heavy transit cost 90 7 Expensive banking service to exporters 142 2. Major ways of export promotion. Out of 600 number average score 93 73 74 75 136 149 Responses 11 6 9 4 30 Responses

% score

13.9 12.4 11.9 12.7 16.1 12.9 20.1 % score

1 2 3 4 5 6 3 1 2 3 4

Tax rebate Procedural reform Helping in quality reform Assist in new market identification Increasing level of government service Open export import Are the provisions of tax system in Industrial Enterprises Act 2049, sufficient? Relevant to present context Need to increase provisions Amend provisions Do not know Total If export related tax rebates are not sufficient, In which tax you think to be reformed? Customs VAT Excise Income tax Other

15.5 12.2 12.3 12.5 22.7 24.8 Percentag e 36.67% 20.00% 30.00% 13.33%

Percentage

1 2 3 4 5

9 6 1 14 0 Total 30 Out of 500 number average score 122 104 68 94 112

30% 20% 3.33% 46.67%

5. What type of customs reform you suggest to motivate exporter? 1 2 3 4 5 Providing bank guarantee facilities Providing bonded warehouse facilities Infrastructure reform in customs Effective duty draws back Administrative reform in customs

% score

24.4 20.8 13.6 18.8 22.4

46

6 1 2 3 4

What reform you suggest in bank guarantee? Present system is good Facilities should be provided to all export oriented industries Should be provided to those exporting more than 60% The system should be alleviated Total Does present income tax make export less competitive? No it is ok Yes it does need reform on tax I dont know

Responses 1 22 6 2 31 Responses

Percentage 3.23% 70.07% 19.35% 6.45%

7 1 2 3

Percentage 16.13% 77.42% 6.45%

5 24 2 Total 31 Responses 16 8 6 Total 30 Responses 5 22 0 1 28 Responses 1 11 12 1 6 31

8 1 2 3

Incase export is levied, how much it should be taxed? On the basis of income On the basis of turn over Income or turnover optional

Percentage 53.33% 26.67% 20.00%

9 1 2 3 4

If tax is levied on the basis of income what should be the rate? Zero rate 5-10 % 10-15 % dont know Total What reform do you suggest in VAT? Present system is right Simplify the reform process Provide bank guarantee to all export oriented industries Compulsory registration to all industry Provide bonded warehouse facility to all Total How do you evaluate present excise system? Present system is sufficient Policy is right, administrative needs reform It is not right, needs alternate system

Percentage 17.86% 78.57% 0.00% 3.57%

10 1 2 3 4 5

Percentage 3.23% 35.48% 38.71% 3.23% 19.35%

11 1 2 3

Responses 2 18 6 Total 26 Responses 9 4 12 Total 25

Percentage 7.69% 69.23% 23.06%

12 1 2 3

If there is the need to reform in excise law? Refund after export Reform the cash deposit after export Refund through one window committee

Percentage 36.00% 16.00% 48.00%

47

14 1 2 3

Does local tax affect export? Need slight reform Reduce tax rate Remove, it is effecting badly

Responses 5 3 22 Total 30 Responses 7 3 8 10 28 Responses 3 16 6 5 Total 30 Responses 8 4 16 1 29 Responses 0 12 10 1 8 29 Responses 1 4 12 9 26

Percentage 16.67 10.00 73.33

15 1 2 3 4

Do you think registration, fee & royalty system has affected industry negatively? Yes, should be removed The rate is alright and it is not effecting No it is not, it should be according to commodity Dont know Total Do you think through the new concept of EPZ & APZ, the export of Nepal will increase? It does not promote export Such concept should be extended Such system is the best one New concept should be adopted

Percentage 25.00 10.71 28.57 35.71

16 1 2 3 4

Percentage 10.00 53.33 20.00 16.67

18 1 2 3 4

What reform do you suggest in present customs tariff on export? Present tariff is right Increase rate for environment polluter Reduce rate to make competitive Nothing Total What improvement you suggest on duty draw back system? Present system is alright Policy is right, procedures should be reformed Refund should be given at customs point on flat rate Introduce pass book to all industry Provide bank guarantee to all industries Total What reforms do you suggest to deemed export & intermediate product? Present system is alright Present policy is right need effective implementation Use bank guarantee or pass book Refund after sale Total What reform do you suggest on barter? Present system is right Policy is right, need administrative reform Present payment system through forex is not good

Percentage 27.59 13.79 55.17 3.45

20 1 2 3 4 5

Percentage 0.00 38.71 32.26 3.23 25.81

21 1 2 3 4

Percentage 3.85 15.38 46.15 34.62

23 1 2 3

Responses 1 15 6 Total 22

Percentage 4.55 69.16 27.27

48

24 1 2 3 4

What kind of facilities do you suggest if export is carried out by other than industries? Same facilities should be given No need of facilities Partial facilities Dont know Total What attempt do you suggest to control unauthorized trade through open border? Adjustment of tariff with neighbor Reform in administrative capacity Physical control in border

Responses 23 2 5 0 30 Responses

Percentage 76.67 6.67 15.67 0.00

25 1 2 3

8 7 13 Total 28

Percentag e 25.57 25.00 46.43

49

Annex 9 Comparative table of prevailing incentives in some neighboring countries. Country Incentives Provisions of incentives and other descriptions

1. Bank loan Pakistan Pre-export For 180 days, 8% interest to direct and indirect export. Central bank reimburse to commercial bank. For 180 days, 8% interest for direct and indirect export. Central bank reimburse to commercial bank. For 180 days, 8% - 9.5% interest to direct and for 270 days 11% -12.5% for indirect export. Central bank reimburse to commercial bank. For 180 days, 8% - 9.5% interest to direct and for 270 days 11% -12.5% for indirect export. Central bank reimburse to commercial bank. For 180 days to 270 days, Cheaper rate of interest. Central bank reimburse to commercial bank. For 180 days to 270 days, Cheaper rate of interest. Central bank reimburse to commercial bank. The finance rate for export credit in foreign

Post export

India

Pre-export

Post export

Bangladesh

Pre-export

Post export

Nepal

currency is 2.0 percent, with a provision that the commercial banks charge not more than 4.0 percent to the borrowers of this facility.
The

refinance rate for export credit in domestic currency has been revised downwards to 3.0 percent from 4.5 percent. loan.

Export finance is covered under priority sector Cash against documents provision has been

improved considerably. Guarantee ratio is revised downwards to 5 percent from 10 percent. 2. Duty drawback Pakistan For manufacturing export Reduced rates of customs duty on import of and gold and silver raw material component not manufactured category locally.

50

India

For imported input and Drawback through advanced licensing and excise on local product or Duty replenishment certificate and in bond input export and DRP For import input paid at Duty suspend to bonded facilities users and the time of import, or cash refund at the time of export through suspended commercial bank
For

Bangladesh

Nepal

bonded facility user duty suspended in import of inputs, after export

Through bank facilities users

guarantee

to

bonded

Through pass book to pass book users Cash duty refund to others after export.

For others duty refund

3. Income tax Pakistan Presumptive tax (20% of the production & scrap if sold locally is treated as export) Equal treatment in slab and rate Equal treatment in slab and rate Tax rate 0.75% on finished product exported. 1% on mineral exported 1.25% on other products exported Tax rate is 35%. There is reduction & rebate on export earning Tax rate is 25%. There is the provision of 50% exemption on taxable income of export earning and other incentive of export earning and other incentive of research & development, marketing, freight, etc. 20% tax in income. Income Tax Act 2001 removed all rebate provided by Industrial Enterprises Act 1992. Article 15 (ka) of the Industrial Enterprises Act 1992 has provided tax rebate to small & handicraft industries. Same provision is still not removed by income tax act, but the income tax administration is still asking for the tax payment.

India

Bangladesh

Nepal

Equal treatment in slab and rate

(Source: Som Nath Aryal A study report related to Nepal Handicraft 2060 in Nepali)

51

Annex 10 Recommendation of different business community and RAC on Export 2061 Agency CNI Policy suggestions Provision of partial release of bank guarantee Specific provisions of classification of machinery of 84 Lab facilities in custom points Export tax should be reduced Duty on raw material should be reduced In deposit clearance after decision all taxes should be refunded Export of used machine should be allowed Duty refund on intermediary raw material Duty on import of raw material less than finished good Provision of Advance ruling No double duty should be there on replacement export or import The import from multinational distributors of India should be allowed RAC should decide before amendment of tax law Provision of equal tariff rate to the article of similar nature Export house & bounded facilities to it should be provided Bounded facilities should be provided in Vat also Export payment should be through l/c and CAD RAC suggestions ___________ ___________ Lab facilities should be provided Export tax should be reduced should be reduced Provisions in ordinance _________ _________ Provision in 3 years plan Reduction started

Suggested Suggested

NOEIA

suggested

RAC should be strengthened suggested Suggested Suggested

national heading mentioned provided

Morang chamber

Sugar industry

Import of sugar should be restricted Quantitative restriction of molasses export should be removed

Should be regulated

52

Gold and Silver Association Birganj chamber of commerce and industry Association of Cement Industry Association of Textile Industry

Reform in baggage rule and reduce tax to promote ornament export Export duty on copper product should be reduced

suggested (kha 4) suggested (kha 4)

Duty on cement and clinker should be adjusted No duty exemption to all import of textile products Valuation should be based on both meter and kg Import from neighboring nations should be through banking channel Bounded facilities to intermediary raw materials product of cotton industry if sold to export oriented industry

suggested

Daber and Liver Butwal Chamber of Commerce Industry

Import tariff of raw material of detergent and shampoo should be reduced Tariff should designed in such a way that the value of local product and imported one should be same Raw material and subsidiary should be provided bounded facilities Duty refund should be settled soon. Re export earning should be tax free Export earning should be taxed on the basis of export transactions. Only 0.5% tax on export earning

suggestion of not providing preferential treatment if payment is not made through bank provision of law could not be implemented procedure is needed (ga3) tariff should be reduced

Suggestions incorporated in ordinance provision already made

Nepal Edible Oil& Ghee Ass. Nepal Overseas Association Dabur Nepal

Morang Chamber of Commerce & Industry

53

Butwal Chamber

Department of Industry provides exemption Inland levied tax , there should be policy adjustment Transaction of export oriented garment industry should be taxed 0.75% only In the import of export oriented industry there should be bonded facility in VAT too Duty refund procedure should be simplified Excisable Indian raw material if imported by export oriented industry the excise duty should be refunded Local tax levied by local level should be removed To control illegal liquor production control molasses sale Suggested Provided in ordinance

Readymade garment FNCCI

Nepal Chamber of commerce CNI

Suggested

FNCCI

Suggested

54

Annex 11 Authorities and stakeholders met during the study Public Sector 1. Mr. Bhanu Prasad Acharya, Secretary, MOF 2. Mr. Dinesh Chandra Pyakurel, Secretary, MOICS. 3. Mr. Bharat Bahadur Thapa, Secretary, MOICS 4. Mr. Purushottam Ojha, Joint Secretary, MOICS 5. Mr. Ram Chandra Man Singh, Joint Secretary, MOF. 6. Mr. Bimal Wagle, Joint Secretary, MOICS. 7. Mr. Krishna Hari Baskota, Director General, DOC. 8. Mr. Avanendra Kumar Shrestha, Director General, DOIR. 9. Mr. T. N. Gautam, Director General, DOI. 10. Ms. Bindra Hada, Director General, DOC. 11. Mr. Tul Raj Basyal, Executive Director, Research Division, NRB. 12. Mr. Naresh Lamichhane, Executive Director, TPC. 13. Mr. Mani Lal Shrestha, TPC.

Private Sector 1. Dr. Roop Jyoti, President, Trans-Himalayan Trade Center. 2. Mr. Badri Prasad Ojha, Secretary General, FNCCI. 3. Dr. Hemant Duwadi, Executive Director, FNCCI. 4. Mr. Kiran Sakha, President, Garment Association of Nepal. 5. Mr. Tribhuwan Dhar Tuladhar, Trans-Himalayan Trade Center. 6. Mr. Prashant Pokhrel, Vice-President, Garment Association of Nepal. 7. Mr. Pashupati Murarka, FNCCI. 8. Mr. Om Prakash Bansal, FNCCI. 9. Mr. Chinpal Rauniyar, Transport Committee, FNCCI.

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10. Mr. Kumud Duggar, President, SAARC Committee, FNCCI. 11. Mr. Madhu Acharya, NCFFA. 12. Mr. Bijaya Mulani, FNCSI 13. Mr. Kabindra B. Shrestha, FNCCI. 14. Mr. Kiran Raj Pandey, AEC 15. Mr. Shanker Pandey, President, NPIA. 16. Mr. Puspa Man Shrestha, Vice-President, NPIA. 17. Mr. Amber Bahadur Thapa, Nepal Lever. 18. Mr. Sudarshan Karki, Dolakha CCI. 19. Mr. D. B. Basnet, FNCCI. 20. Mr. Kedar Man Singh Shrestha, FNCCI. 21. Mr. Priya Darshan Sharma, FNCCI. 22. Dr. D. B. Shakya, AEC. 23. Mr. Kiran Prasad Pathak, HCPCC. 24. Mr. Jeevan Kansakar, FNCCI. 25. Mr. Kalyan Krishna Tamrakar, President, Handicraft Association of Nepal. 26. Mr. Swayabhu Tuladhar, Vice-President, Handicraft Association of Nepal. 27. Mr. Giri Raj Gyawali, Joint Secretary, Central Carpet Association of Nepal. 28. Mr. Kabindra Nath Thakur, President, Association of Carpet Exporters. 29. Mr. Satish Kumar More, NFTA. 30. Mr. Min Bhadur Karki, Secretary General, CNI. 31. Mr. Sushil Basnet, Secretary General, Nepal Chamber of Commerce.

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Bibliography 1. 2. 3. WCO Publication (2000) Kyoto Convention general Annex guidelines. The World Bank (2003) Customs administrations impediments to trade and investment, FDI Roundtable, Male. Kafle Keshab and Michal Welling (1994) Import and Export procedure Multimodel Transport and Trade Facilitation Project paper UNCTAD, Kathmandu, Nepal MOIC (2004) Nepal trade and competitiveness study. Som Nath Aryal (2003), A study report related to Nepal Handicraft (Nepali) Management Association of Nepal, June 2003, Seminar paper on prospects and Challenges of PPP in Nepal. Research and Study Center, Kathmandu, A study on the preparation of the long term Export Promotion Plan and Strategies. Trade Promotion Center, Nepal Oversees Trade Strategies 2003/2004. National Planning Commission HMG/N, Tenth Five year Plan 2002-2007. ADB Country Strategies and Program Nepal 2005-2009. Ministry of Finance HMG/N, Economic Survey, Fiscal Year 2003/2004. Nepal Rastra Bank, January 2005, Current Macroeconomic Situation of Nepal. MOICS, Department of Commerce 2004, Foreign Trade Manual. Document on Reform of Export Tax Rebate System, experience of China, USA, Canada, Argentina and SAARC countries. MOF, Economic survey 2003/04

4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15.

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